Peoples Financial Corp.
Annual Report 2011

Plain-text annual report

P E O P L E S F I N A N C I A L C O R P O R A T I O N A N D S U B S I D I A R I E S 2 0 1 1 A N N U A L R E P O R T P E O P L E S F I N A N C I A L C O R P O R A T I O N A N D S U B S I D I A R I E S T O O U R S H A R E H O L D E R S Dear shareholders, As we look at 2011 in the rear view mirror, we see a year that showed some measured success, a lot of painful decisions and perhaps a significant turn in the economic environment that has plagued our country and our region for nearly four years. The year produced a number of positive results: • Loan volume increased 5.5% over 2010, which exceeded our original 2011 projection of a net decrease for the year. • The semi-annual dividend for the second half of 2011 was increased from $.09 to $.10, indicating the confidence your Board of Directors and senior management team have in our future earnings. • Our book value per share rose nearly 8% to $21.31 per share. • Our primary capital ratio rose to 14.65%, the highest since 2004. • Loan loss provision for 2011 dropped by about 60%, even though the total allowance for loan losses at the end of 2011 is larger than the previous year, reflecting our conservative approach to our loan portfolio. However, the good news was accompanied by a large measure of pain, as your senior management team spent much of the year cleaning up our balance sheet to prepare us for greater growth and profitability as the economy turns up in the future. The result of this process is that for the year, your bank earned $1,203,000, some 19% less than 2010. Results in 2011 included charged-off interest on nonaccrual loans of $783,000, net of taxes. Foreclosures in 2011 totaled $3,222,000, which is another part of the process of managing non-performing loans. Your bank is working diligently to liquidate these assets, and during 2011 sold other real estate with a carrying value of $2,101,000. Losses on other real estate for the year totaled $588,000, net of taxes, including losses on sales and writedowns of property to market value. The year started with promise, as we posted improved earnings for the first two quarters. However, similar to our experience in 2010, the second half of the year was far more challenging, even though we began to see some positive signs in our economy as evidenced by a small increase in loan volume. Fourth quarter 2011 income showed a loss of $622,000, due mostly to expenses of $523,000, net of taxes, related to an early retirement program. In addition, the bank charged off $394,000, net of taxes, in interest from loans placed on nonaccrual status and provided $795,000, net of taxes, for loan losses during the quarter. The net result of these difficult decisions is that your bank is emerging from this recessionary cycle with a cleaner balance sheet and a stronger capital foundation. Federal policy makers have made it abundantly clear that they intend to keep interest rates unnaturally low for an extended period that may stretch to years. While that may benefit a few big business entities with large capital requirements, it does little to help individual savers, small business job creators, pensioners and community banks. The ability to earn a reasonable return on invested capital is fundamental to the financial industry. When that ability is severely restricted, we cannot pay our depositors more than we can earn on funds, which squeezes everyone. Until the business cycle accelerates to the point that increased activity will nudge interest rates off the floor, the overall economy will continue to bounce along a fairly rough bottom. Few may fail, but fewer will prosper under these conditions. We can only play by the rules handed to us. We do not set the rules. Congress and the Federal Reserve do that. Your team of directors, senior manage- ment and bankers remain focused on the profitability of this bank under these circumstances. We will accomplish this with strict cost controls, attention to customer service and aggressive pursuit of what business there is. On behalf of everyone on the team, thank you for your continued support. Sincerely yours, Chevis C. Swetman Chairman of the Board President & Chief Executive Officer MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Peoples Financial Corporation (the “Company”) is a one-bank holding company headquartered in Biloxi, Mississippi. The following presents Management’s discussion and analysis of the consolidated financial condition and results of operations of the Company and its consolidated subsidiaries for the years ended December 31, 2011, 2010 and 2009. These comments highlight the significant events for these years and should be considered in combination with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included in this annual report. FF OO RR WW AA RR DD -- LL OO OO KK II NN GG II NN FF OO RR MM AA TT II OO NN Congress passed the Private Securities Litigation Act of 1995 in an effort to encourage corporations to provide information about a company’s anticipat- ed future financial performance. This act provides a safe harbor for such disclosure which protects the companies from unwarranted litigation if actual results are different from management expectations. This report contains forward-looking statements and reflects industry conditions, company perform- ance and financial results. These forward-looking statements are subject to a number of factors and uncertainties which could cause the Company’s actual results and experience to differ from the anticipated results and expectations expressed in such forward-looking statements. Such factors and uncertainties include, but are not limited to: changes in interest rates and market prices, changes in local economic and business conditions, increased competition for deposits and loans, a deviation in actual experience from the underlying assumptions used to determine and establish the allowance for loan losses, changes in the availability of funds resulting from reduced liquidity, changes in government regulations and acts of terrorism, weather or other events beyond the Company’s control. NN EE WW AA CC CC OO UU NN TT II NN GG PP RR OO NN OO UU NN CC EE MM EE NN TT SS The Financial Accounting Standards Board (“FASB”) has issued new accounting standards updates, which have been disclosed in Note A to the Consolidated Financial Statements. The Company does not expect that these updates will have a material impact on its results of operations or financial position. As the Company currently presents changes in comprehensive income in the Consolidated Statement of Changes in Shareholders’ Equity and Comprehensive Income, the adoption of Accounting Standards Update No. 2011-05 will result in a change in how comprehensive income is presented. CC RR II TT II CC AA LL AA CC CC OO UU NN TT II NN GG PP OO LL II CC II EE SS The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabil- ities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company evaluates these estimates and assumptions on an on-going basis using historical experience and other factors, including the current economic environment. We adjust such estimates and assumptions when facts and circumstances dictate. Certain critical accounting policies affect the more significant estimates and assumptions used in the preparation of the consolidated financial statements. Allowance for loan losses: The Company’s most critical accounting policy relates to its allowance for loan losses (“ALL”), which reflects the estimated losses resulting from the inabil- ity of its borrowers to make loan payments. The ALL is established and maintained at an amount sufficient to cover the estimated loss associated with the loan portfolio of the Company as of the date of determination. Credit losses arise not only from credit risk, but also from other risks inherent in the lend- ing process including, but not limited to, collateral risk, operation risk, concentration risk and economic risk. As such, all related risks of lending are con- sidered when assessing the adequacy of the ALL. On a quarterly basis, Management estimates the probable level of losses to determine whether the allowance is adequate to absorb reasonably foreseeable, anticipated losses in the existing portfolio based on our past loan loss experience, known and inherent risk in the portfolio, adverse situations that may affect the borrowers’ ability to repay and the estimated value of any underlying collateral and current economic conditions. Management believes that the ALL is adequate and appropriate for all periods presented in these financial statements. If there was a deterioration of any of the factors considered by Management in evaluating the ALL, the estimate of loss would be updated, and additional provisions for loan losses may be required. The analysis divides the portfolio into two segments: a pool analysis of loans based upon loss history which may be adjusted by qualitative factors by loan type and a specific reserve analysis for those loans considered impaired under generally accepted account- ing principles. All credit relationships with an outstanding balance of $100,000 or greater that are included in Management’s loan watch list are individ- ually reviewed for impairment. All losses are charged to the ALL when the loss actually occurs or when a determination is made that a loss is likely to occur; recoveries are credited to the ALL at the time of receipt. Employee Benefit Plans: Employee benefit plan liabilities and pension costs are determined utilizing actuarially determined present value calculations. The valuation of the benefit obligation and net periodic expense is considered critical, as it requires Management and its actuaries to make estimates regarding the amount and timing of expected cash outflows including assumptions about mortality, expected service periods and the rate of compensation increases. Income Taxes: GAAP requires the asset and liability approach for financial accounting and reporting for deferred income taxes. We use the asset and liability method of accounting for deferred income taxes and provide deferred income taxes for all significant income tax temporary differences. See Note J to the Consolidated Financial Statements for additional details. As part of the process of preparing our consolidated financial statements, the Company is required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as the provision for loan losses, for tax and financial reporting purposes. These differences result in deferred tax assets and liabilities that are included in our consolidated statement of condition. We must also assess the likelihood that our deferred tax assets will be recovered from future taxable income, and to the extent we believe that recovery is not like- ly, we must establish a valuation allowance. Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. To the extent the Company establishes a valuation allowance or adjusts this allowance in a period, we must include an expense within the tax provisions in the statement of income. 1 OO VV EE RR VV II EE WW The Company is a community bank serving the financial and trust needs of its customers in our trade area, which is defined as those portions of Mississippi, Louisiana and Alabama which are within a fifty mile radius of the Waveland, Wiggins and Gautier branches, the bank subsidiary’s three most outlying locations. Maintaining a strong core deposit base and providing commercial and real estate lending in our trade area are the traditional focus- es of the Company. Growth has largely been achieved through de novo branching activity, and it is expected that these strategies will continue to be emphasized in the future. Net income for 2011 was $1,202,834 compared with $1,484,963 for 2010. This decrease resulted from the charge-off of interest income on loans placed on nonaccrual, the decreased yield on investment securities and write downs of other real estate (“ORE”). Results for 2011 also included a decrease in the provision for loan losses as compared with 2010, gains on death benefits from life insurance policies, and costs associated with a voluntary early retire- ment program offered during 2011. Monitoring and managing asset quality and non-performing assets continue to be emphasized during these difficult economic times, as the local and national economy continues to negatively impact collateral values and borrowers’ ability to repay their loans. During 2011, past due loans increased sig- nificantly and resulted in a large increase in loans being placed on nonaccrual and $1,187,037 in accrued interest being charged-off. Nonaccrual loans increased significantly to $57,592,715 at December 31, 2011 as compared with $14,537,098 at December 31, 2010. Commercial real estate loans totaling $8,331,309 were placed on nonaccrual during 2011 as a result of the borrowers filing for bankruptcy. Residential and land development loans totaling $23,478,058 and commercial construction loans totaling $6,041,822 were placed on nonaccrual during 2011. The Company has allocated a total specific reserve of $2,106,729 to loans on nonaccrual as of December 31, 2011. Managing the net interest margin in the Company’s highly competitive market and in context of larger national economic conditions has been very chal- lenging and will continue to be so for the foreseeable future. While interest income on loans was impacted by charged-off interest, net interest income was also affected by decreasing yields on investment securities. Specifically, interest income on U.S. Agencies decreased $2,277,914, largely due to a decrease in yield from 3.24% to 2.10%. Declining real estate values resulted in write downs of the ORE portfolio of $711,006 during 2011. While past due and non accrual loans are much higher than desirable, there are positive trends as net charge-offs decreased from $8,023,085 in 2010 to $1,449,636 in 2011 and the provision of loan losses decreased $3,910,000 in 2011 as compared with 2010. As a result of the death of participants in deferred compensation plans during 2011, the Company realized gains on death benefits from life insurance poli- cies of $469,740. During 2011, an early retirement program was offered to certain employees. While 2011 results included additional costs of $851,406 from the program, the Company expects to reduce salaries and employee benefit expense in future years as a result of these retirements. Total assets at December 31, 2011 increased $17,606,606, as compared with December 31, 2010. Loan demand exceeded expectations in 2011, as loans increased $22,508,529. Federal funds purchased and securities sold under agreements to repurchase increased $17,498,948 and borrowings from the Federal Home Loan Bank (“FHLB”) increased $10,366,552 at December 31, 2011 as compared with December 31, 2010, which funded the increase in loans and the decrease in total deposits of $15,700,433 for the same period. RR EE SS UU LL TT SS OO FF OO PP EE RR AA TT II OO NN SS NNeett IInntteerreesstt IInnccoommee Net interest income, the amount by which interest income on loans, investments and other interest- earning assets exceeds interest expense on deposits and other borrowed funds, is the single largest component of the Company’s income. Management’s objective is to provide the largest possible amount of income while balancing interest rate, credit, liquidity and capital risk. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities combined with changes in market rates of interest directly affect net interest income. The Federal Open Market Committee (the “Committee”), a component of the Federal Reserve System, is charged under United States law with overseeing the nation’s open market operations by making key deci- sions about interest rates and the growth of the U.S. money supply. The Committee dropped the discount rate significantly in 2008 and has not adjusted the rate since that time, which impacted interest rates then and in succeeding years. The Committee has indicated that the discount rate will not be adjust- ed until 2014 at the earliest. 2011 as compared with 2010 The Company’s average interest-earning assets decreased approximately $31,744,000, or 4%, from approximately $754,060,000 for 2010 to approximate- ly $722,316,000 for 2011. The Company’s average balance sheet shrunk primarily as principal payments, maturities, charge-offs and foreclosures relating to existing loans have outpaced new loans during the first part of 2011. While the average balance sheet decreased for the year, loan demand increased during the last two quarters of 2011 which resulted in an increase in loans at December 31, 2011. The average yield on earning assets decreased 46 basis points, from 4.03% for 2010 to 3.57% for 2011, with the biggest impact being to the yield on tax- able available for sale securities. The Company’s investment and liquidity strategy has been to invest most of the proceeds from sales, calls and maturi- ties of securities in similar securities with a maturity of two years or longer, the interest rates on which have decreased dramatically. As a result, the yield on taxable available for sale securities decreased from 3.24% for 2010 to 2.10% for 2011. Beginning in the fourth quarter of 2010, Management began acquir- ing such securities with a maturity of five years or longer in order to improve the yield. The charge off of interest income on loans of $1,187,037 during 2011 reduced the average yield on earning assets by 16 basis points. Average interest-bearing liabilities decreased approximately $25,195,000, or 4%, from approximately $613,157,000 for 2010 to approximately $587,962,000 for 2011. The average rate paid on interest-bearing liabilities decreased 21 basis points, from .75% for 2010 to .54% for 2011. The Company believes that it is unlikely that its cost of funds can be materially reduced further. The Company’s net interest margin on a tax-equivalent basis, which is net interest income as a percentage of average earning assets, was 3.13% at December 31, 2011, down 29 basis points from 3.42% at December 31, 2010, primarily due to the charge-off of interest income on loans and the decrease in yield on taxable available for sale securities. 2 2010 as compared with 2009 The Company’s average interest-earning assets decreased approximately $65,566,000, or 8%, from approximately $819,626,000 for 2009 to approximate- ly $754,060,000 for 2010. The Company’s average balance sheet shrunk as principal payments and maturities of loans have outpaced new loans and invest- ments have been called or sold. As a result of the Committee’s actions, the average yield on earning assets decreased 23 basis points, from 4.26% for 2009 to 4.03% for 2010, with the biggest impact being to the yield on taxable available for sale securities. The Company’s investment and liquidity strategy was to invest most of the proceeds from sales and calls of securities in similar securities with a maturity of two years or longer, the interest rates on which have decreased dramatically. As a result, the yield on taxable available for sale securities decreased from 4.18% for 2009 to 3.24% for 2010. Beginning in the fourth quarter of 2010, Management began acquiring such securities with a maturity of five years or longer in order to improve the yield. The Company’s loan portfolio generally has a 40%/60% blend of fixed/floating rate term. In addition to adjusting the duration of investment purchases, the Company established floors on new and renewing loans in order to improve the net interest margin. Along with the impact of the calls of securities, this results in the Company being more asset sensitive to market interest rates and generally is the cause of the decrease in interest income. Average interest-bearing liabilities decreased approximately $68,869,000, or 10%, from approximately $682,026,000 for 2009 to approximately $613,157,000 for 2010. The aver- age rate paid on interest-bearing liabilities decreased 34 basis points, from 1.09% for 2009 to .75% for 2010. This dramatic decrease is the result of utilizing lower cost funding sources including brokered deposits and Federal Home Loan Bank advances in 2010 as compared with 2009. The Company’s net interest margin on a tax-equivalent basis, which is net interest income as a percentage of average earning assets, was 3.42% at December 31, 2010, up 6 basis points from 3.36% at December 31, 2009. The tables below analyze the changes in tax-equivalent net interest income for the years ended December 31, 2011 and 2010 and the years ended December 31, 2010 and 2009. A N A L Y S I S O F A V E R A G E B A L A N C E S , I N T E R E S T E A R N E D / P A I D A N D Y I E L D ( I N T H O U S A N D S ) Loans (2) (3) Federal Funds Sold Held to maturity: Non taxable (1) Available for sale: Taxable Non taxable (1) Other Total Savings and demand, interest bearing Time deposits Federal funds purchased and securities sold under agreements to repurchase Borrowings from FHLB Total Net tax-equivalent yield on earning assets Loans (2) (3) Federal Funds Sold Held to maturity: Non taxable (1) Available for sale: Taxable Non taxable (1) Other Total Savings and demand, interest bearing Time deposits Federal funds purchased and securities sold under agreements to repurchase Borrowings from FHLB Total Net tax-equivalent yield on earning assets 2011 Average Balance 405,367 $ 2,857 Interest Earned/Paid Rate 4.42 $ 0.25 17,923 7 1,882 269,401 39,941 2,868 722,316 226,097 169,617 $ $ 107 5,662 2,041 23 $ 25,763 $ 819 1,535 154,423 37,825 $ 587,962 638 186 $ 3,178 5.69 2.10 5.11 0.80 3.57 0.36 0.90 0.41 0.49 0.54 3.13 Average Balance 436,393 $ 4,842 2,938 264,927 40,581 4,379 754,060 217,531 190,718 $ $ 2010 Interest Earned/Paid $ 19,687 15 154 8,589 1,903 26 $ 30,374 $ 1,084 2,173 152,000 52,908 $ 613,157 991 352 $ 4,600 2010 Average Balance 436,393 $ 4,842 Interest Earned/Paid Rate 4.51 $ 19,687 0.31 15 2009 Average Balance 467,992 $ 3,227 Interest Earned/Paid $ 20,189 8 2,938 264,927 40,581 4,379 754,060 217,531 190,718 $ $ 154 8,589 1,903 26 $ 30,374 $ 1,084 2,173 152,000 52,908 $ 613,157 991 352 $ 4,600 5.24 3.24 4.69 0.59 4.03 0.50 1.14 0.65 0.65 0.75 3.42 3,265 307,332 34,437 3,373 819,626 232,916 192,893 $ $ 172 12,840 1,699 17 $ 34,925 $ 1,831 3,135 217,509 38,708 $ 682,026 1,905 530 $ 7,401 (1) All interest earned is reported on a taxable equivalent basis using a tax rate of 34% in 2011, 2010 and 2009. (2) Loan fees of $647, $611 and $476 for 2011, 2010 and 2009, respectively, are included in these figures. (3) Includes nonaccrual loans. 3 Rate 4.51 0.31 5.24 3.24 4.69 0.59 4.03 0.50 1.14 0.65 0.65 0.75 3.42 Rate 4.31 0.25 5.27 4.18 4.93 0.50 4.26 0.79 1.63 0.88 1.37 1.09 3.36 PPrroovviissiioonn ffoorr LLooaann LLoosssseess In the normal course of business, the Company assumes risk in extending credit to its customers. This credit risk is managed through compliance with the loan policy, which is approved by the Board of Directors. The policy establishes guidelines relating to underwriting standards, including but not limited to financial analysis, collateral valuation, lending limits, pricing considerations and loan grading. A loan review process further assists with evaluating credit quality and assessing potential performance issues. Loan delinquencies and deposit overdrafts are closely monitored in order to identify develop- ing problems as early as possible. In addition, the Company continuously monitors its relationships with its loan customers in concentrated industries such as gaming and hotel/motel, as well as the exposure for out of area, land, development, construction and commercial real estate loans, and their direct and indirect impact on its operations. A monthly watch list of credits which pose a potential loss to the Company is prepared based on the loan grading system. This list forms the foundation of the Company’s allowance for loan loss computation. Management relies on its guidelines and existing methodology to monitor the performance of its loan portfolio and to identify and estimate potential losses based on the best available information. The potential effect of the economic downturn on a national and local level, the decline in real estate val- ues and actual losses incurred by the Company were key factors in our analysis. Note A to the Consolidated Financial Statements discloses a summary of the accounting principles applicable to impaired and nonaccrual loans as well as the allowance for loan losses. Note C to the Consolidated Financial Statements presents additional analyses of the composition, aging and performance of the loan portfolio as well as the transactions in the allowance for loan losses. The decline in the value of real estate has negatively impacted the collateral relating to the Company’s residential and land development and real estate – mortgage portfolios. The Company’s evaluation of these portfolios and related collateral resulted in a significant increase in provisions for the devel- opment portfolio in 2009 and 2010 and for the real estate-mortgage portfolio in 2011. The Company’s on-going, systematic evaluation resulted in the Company recording a total provision for loan losses of $2,935,000, $6,845,000 and $5,225,000 in 2011, 2010 and 2009, respectively. Net charge-offs decreased dramatically in 2011 to $1,449,636 from $8,023,085 and $8,511,174 in 2010 and 2009, respectively, as the Company has worked diligently to address non-performing loans. The allowance for loan losses as a percentage of loans was 1.88%, 1.62% and 1.68% at December 31, 2011, 2010 and 2009, respectively. Even though nonac- crual loans grew to $57,592,715 at December 31, 2011, only $2,106,729 in specific reserves has been allocated to these loans as collateral value appear suf- ficient to cover loan losses. The Company believes that its allowance for loan losses is appropriate as of December 31, 2011. The allowance for loan losses is an estimate, and as such, events may occur in the future which may affect its accuracy. The Company anticipates that it is possible that additional information will be gathered in the future which may require an adjustment to the allowance for loan losses. Management will continue to closely monitor its portfolio and take such action as it deems appropriate to accurately report its financial condition and results of operations. NNoonn--iinntteerreesstt iinnccoommee Total non-interest income decreased by $253,954 in 2011 as compared with 2010. Included in this decrease was a decrease in service charges on deposit accounts of $319,817 in 2011 as compared with 2010 as these fees were impacted by the local economy and customers opting out of overdraft protection for debit card transactions. During 2010, secu- rities were sold at a gain of $1,690,670 as compared with only $1,126,055 in 2011 as the Company executed sales when it could maximize proceeds. As a result of the death of par- ticipants in the Company’s deferred compensation plans, bank owned life insurance was redeemed in 2011, resulting in a gain of $469,740. The Company’s other investments had a gain of $96,969 in 2011 as compared with a loss of $109,933 in 2010. Total non-interest income decreased slightly by $32,471 in 2010 as compared with 2009. Included in this decrease, however, was a decrease in service charges on deposit accounts of $558,076 in 2010 as compared with 2009 as these fees were impacted by the local economy and customers opting out of overdraft protection for debit card transactions. During 2010, securities were sold at a gain of $1,690,670 as compared with only $869,123 in 2009 as the Company executed sales when it could maximize proceeds. The Company’s other investments had a loss of $109,933 in 2010 as compared with a gain of $146,979 in 2009. In 2009, non- interest income included a loss of $149,517 from the writedown of equity investments. NNoonn--iinntteerreesstt eexxppeennssee Total non-interest expense increased by $1,199,608 in 2011 as compared with 2010. Salaries and employee benefits increased $501,777 in 2011 as compared with 2010. While the Company had been able to reduce salaries and employee benefits through attrition in 2011 and 2010, current year expenses included additional costs of $851,406 relating to the early retirement program. Equipment rentals, depreciation and maintenance decreased $336,297 in 2011 as compared with 2010. Rental expense decreased $135,531 in 2011 as the Company discontinued use of leased equipment. Depreciation on furniture and equipment decreased $133,000 as equipment replaced after Hurricane Katrina is now fully depreciated. Maintenance costs decreased $59,766 as a result of a number of cost saving measures. Other expense increased $1,048,202 for 2011 as compared with 2010. Included in other expense are data processing expense, which increased $291,359 as a result of the outsourcing of most of the bank’s I/T functions, and ORE expenses, which were $938,486 more in 2011 as compared with 2010 primarily as a result of write downs of $711,006. Other expense also includes FDIC and state banking assessments. Based on formu- las determined by those agencies, the bank subsidary was assessed $177,940 more in 2011 than in the previous year. These increases in other expenses were partially reduced by the decrease in advertising and legal costs. Advertising expenses decreased $74,018 in 2011 as a result of cost savings measures. Legal fees decreased $176,756 in 2011 as compared with 2010 due to the resolution of a number of non-performing loan issues. Total non-interest expense decreased by $54,306 in 2010 as compared with 2009. Salaries and employee benefits decreased $668,274 in 2010 as compared with 2009 as a result of the decrease in the number of employees from attrition in 2009 and 2010. Net occupancy costs decreased $137,328 in 2010 as com- pared with 2009 as a result of decreased insurance and property tax costs. Insurance costs decreased $84,591 as the Company was able to reduce premi- ums on some of its liability coverage. Property tax expense decreased $44,635 due to the revaluation of some of the Company’s real property. Other expense increased $849,235 for 2010 as compared with 2009. This increase is the result of increased legal, data processing, franchise and other expenses as well as an increase in costs associated with managing our other real estate portfolio. Legal fees increased $236,862 in 2010 as compared with 2009 as the Company engaged legal counsel to assist with several non-performing loan issues. Data processing costs increased $186,683 as a result of the out- 4 sourcing of some of the bank’s I/T functions. Franchise tax expense increased $246,774 in 2010 as compared with 2009 as prior years’ refunds were received in 2009. Maintenance and repairs, property taxes, disposal costs and losses on sales of other real estate were $250,865 more in 2010 as compared with 2009 as a result of the increase in the number of foreclosures in 2010. While the Company had increased costs in these areas, it was able to reduce expenses as a part of a cost-cutting campaign in 2010 for a savings of more than approximately $385,000. Savings were realized in advertising, consulting, trust, dues, training and other expenditures. IInnccoommee TTaaxxeess Income taxes have been impacted by non-taxable income and federal tax credits during 2011, 2010 and 2009, respectively. Note J to the Consolidated Financial Statements presents a reconciliation of income taxes for these three years. FF II NN AA NN CC II AA LL CC OO NN DD II TT II OO NN Available for sale securities decreased $8,159,982 at December 31, 2011, compared with December 31, 2010. Proceeds from the sales, calls and maturities of these securities and the increase in other borrowings fund the increase in loans and decrease of deposits. The Company’s held to maturity portfolio was invested solely in debt securities issued by state and political subdivisions at December 31, 2011 and December 31, 2010. Proceeds from maturities of these securities are reinvested in available for sale securities or loans. The Company increased its investment in Federal Home Loan Bank common stock by $299,500 as a result of increased need for borrowing capacity from that agency during 2011. Gross loans increased $22,508,529 at December 31, 2011 as compared with December 31, 2010 as new loans outpaced payments, maturities, foreclosures and charge-offs. The Company anticipates that moderate growth will continue in 2012. Other real estate increased by $409,088 at December 31, 2011 as compared with December 31, 2010. During 2011, loans totaling $3,221,510 were transferred into ORE, write downs of $711,006 were charged to earnings and ORE totaling $2,101,416 was sold. The Company is working diligently and prudently to reduce this portfolio. Interest rates on interest-earning assets, particularly available for sale securities, have decreased at December 31, 2011 as compared with December 31, 2010. This trend directly impacted accrued interest receivable, which decreased $594,189 during 2011. Prepaid FDIC assessments decreased $1,556,652 at December 31, 2011 as compared with December 31, 2010 as a result of the amortization of these costs. Other assets decreased $4,638,299 at December 31, 2011 as compared with December 31, 2010. At December 31, 2010, the Company recorded federal income taxes receivable of $2,459,715 as a result of overpayments as compared with $345,000 at December 31, 2011. Also included in other assets was a decrease in deferred tax assets of $2,133,781 as the increase in the fair value of available for sale securities changed from an unrealized loss to an unrealized gain. Prepaid expenses included in other assets decreased $285,776 as a result of the amortization of these costs. Total deposits decreased $15,700,433 at December 31, 2011, as compared with December 31, 2010. Fluctuations among the different types of deposits repre- sent recurring activity for the Company. The Company anticipates that deposits will continue at or slightly above their present level during 2012. Federal funds purchased and securities sold under agreements to repurchase, which includes non-deposit accounts, increased $17,498,948 at December 31, 2011 as compared with December 31, 2010, as customers periodically reallocate their funds. Borrowings from the Federal Home Loan Bank increased $10,366,552 at December 31, 2011 as compared with December 31, 2010 based on the liquidity needs of the bank subsidiary. Other liabilities decreased $2,653,900 at December 31, 2011 as compared with December 31, 2010 as a result of net decrease in the liabilities relating to the Company’s deferred compensation plans. The liability increased $2,384,875 for these plans, which included additional accruals as a result of the early retirement program. At December 31, 2011, the retiree health plan was amended, which reduced the accumulated post-retirement benefit obligation by $4,818,468. Note P to the Consolidated Financial Statements describes the Company’s deferred compensation plans and the amendment to the retiree health plan. SS HH AA RR EE HH OO LL DD EE RR SS ’’ EE QQ UU II TT YY AA NN DD CC AA PP II TT AA LL AA DD EE QQ UU AA CC YY Strength, security and stability have been the hallmark of the Company since its founding in 1985 and of its bank subsidiary since its founding in 1896. A strong capital foundation is fundamental to the continuing prosperity of the Company and the security of its customers and shareholders. The primary and risk-based capital ratios are important indicators of the strength of a company’s capital. These figures are presented in the Five-Year Comparative Summary of Selected Financial Information. The measure of capital adequacy which is currently used by Management to evaluate the strength of the Company’s capital is the primary capital ratio which was 14.65 % at December 31, 2011, which is well above the regulatory minimum of 6.00%. Management continues to emphasize the importance of maintaining the appropriate capital levels of the Company and has established the goal of maintaining its primary capital ratio at 8.00%, which is the minimum requirement for classification as being “well-capitalized” by the banking regulatory authorities. Significant transactions affecting shareholders’ equity during 2011 are described in Note K to the Consolidated Financial Statements. The Statement of Changes in Shareholders’ Equity and Comprehensive Income also presents all activity in the Company’s equity accounts. 5 LL II QQ UU II DD II TT YY Liquidity represents the Company’s ability to adequately provide funds to satisfy demands from depositors, borrowers and other commitments by either converting assets to cash or accessing new or existing sources of funds. Note M to the Consolidated Financial Statements discloses information relating to financial instruments with off-balance-sheet risk, including letters of credit and outstanding unused loan commitments. The Company closely monitors the potential effects of funding these commitments on its liquidity position. Management monitors these funding requirements in such a manner as to satisfy these demands and to provide the maximum return on its earning assets. The Company monitors and manages its liquidity position diligently through a number of methods, including through the computation of liquidity risk targets and the preparation of various analyses of its funding sources and utilization of those sources on a monthly basis. The Company also uses profor- ma liquidity projections which are updated on a continuous basis in the management of its liquidity needs and also conducts contingency testing on its liquidity plan. The Company has also been approved to participate in the Federal Reserve’s Discount Window Primary Credit Program, which it intends to use only as a contingency. Management carefully monitors its liquidity needs, particularly relating to potentially volatile deposits, and the Company has encountered no problems with meeting its liquidity needs. Deposits, payments of principal and interest on loans, proceeds from maturities of investment securities and earnings on investment securities are the princi- pal sources of funds for the Company. The Company also uses other sources of funds, including borrowings from the Federal Home Loan Bank. The Company generally anticipates relying on deposits, purchases of federal funds and advances from the Federal Home Loan Bank for its liquidity needs in 2012. RR EE GG UU LL AA TT OO RR YY MM AA TT TT EE RR SS During 2009, Management identified opportunities for improving risk management, addressing asset quality concerns, managing concentrations of cred- it risk and ensuring sufficient liquidity at the Bank as a result of its own investigation as well as examinations performed by certain bank regulatory agen- cies. In concert with the regulators, the Company has identified specific corrective steps and actions to enhance its risk management, asset quality and liquidity policies, controls and procedures. The Company and the Bank may not declare or pay any cash dividends without the prior written approval of their regulators. OO FF FF -- BB AA LL AA NN CC EE SS HH EE EE TT AA RR RR AA NN GG EE MM EE NN TT SS The Company is a party to off-balance-sheet arrangements in the normal course of business to meet the financing needs of its customers. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet arrangements. Since some of the com- mitments and irrevocable letters of credit may expire without being drawn upon, the total amount does not necessarily represent future cash require- ments. As discussed previously, the Company carefully monitors its liquidity needs and considers its cash requirements, especially for loan commitments, in making decisions on investments and obtaining funds from its other sources. Further information relating to off-balance-sheet instruments can be found in Note M to the Consolidated Financial Statements . QQ UU AA NN TT II TT AA TT II VV EE AA NN DD QQ UU AA LL II TT AA TT II VV EE DD II SS CC LL OO SS UU RR EE AA BB OO UU TT MM AA RR KK EE TT RR II SS KK Market risk is the risk of loss arising from adverse changes in market prices and rates. Interest rate risk is the most significant market risk affecting the Company. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company’s business activities. Also, the Company does not currently, and has no plans to, engage in trading activities or use derivative or off-balance sheet instruments to manage interest rate risk. The Company has risk management policies in place to monitor and limit exposure to market risk. The Asset/Liability Committee (“ALCO Committee”), whose members include the chief executive officer, the executive vice president, the chief risk officer and other senior and middle management from the financial, lending, investing, and deposit areas of the bank subsidiary, is responsible for the day-to-day operating guidelines, approval of strategies affecting net interest income and coordination of activities within policy limits established by the Board of Directors based on the Company’s tolerance for risk. Specifically, the key objectives of the Company’s asset/liability management program are to manage the exposure of planned net interest mar- gins to unexpected changes due to interest rate fluctuations. These efforts will also affect loan pricing policies, deposit interest rate policies, asset mix and volume guidelines and liquidity. The ALCO Committee utilizes a number of tools in its activities, including software to assist with interest rate risk management and balance sheet management. The ALCO Committee reports to the Board of Directors on a quarterly basis. The Company has implemented a conservative approach to its asset/liability management. The net interest margin is managed on a daily basis largely as a result of the management of the liquidity needs of the bank subsidiary. The Company generally follows a policy of investing in U.S. Agency securities with maturities of two years or more. Due to the low interest rate environment, the duration of investments has been extended to fifteen years with call provisions. The loan portfolio consists of a 40% /60% blend of fixed and floating rate loans. It is the general loan policy to offer loans with maturities of five years or less; however, the market is now dictating floating rate terms to be extended to fifteen years. On the liability side, more than 65% of the deposits are demand and savings transaction accounts. Additionally, 89% of the certificates of deposit mature within eighteen months. Since the Company’s deposits are generally not rate-sensitive, they are considered to be core deposits. The short term nature of the financial assets and liabilities allows the Company to meet the dual requirements of liquidity and interest rate risk management. 6 The interest rate sensitivity tables below provide additional information about the Company’s financial instruments that are sensitive to changes in inter- est rates. The negative gap in 2012 is mitigated by the nature of the Company’s deposits, whose characteristics have been previously described. The tab- ular disclosure reflects contractual interest rate repricing dates and contractual maturity dates. Loan maturities have been adjusted for reserve for loan losses. There have been no adjustments for such factors as prepayment risk, early calls of investments, the effect of the maturity of balloon notes or the early withdrawal of deposits. The Company does not believe that the aforementioned factors have a significant impact on expected maturity. Interest rate sensitivity at December 31, 2011 was as follows (in thousands): 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 B E Y O N D T O T A L 1 2 / 3 1 / 1 1 F A I R V A L U E $ 279,302 $ 27,756 $ 35,559 $ 18,707 $ 22,032 $ 40,991 $ 424,347 $ 427,881 Interest rate sensitivity at December 31, 2010 was as follows (in thousands): 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 B E Y O N D T O T A L 1 2 / 3 1 / 1 0 F A I R V A L U E $ 297,654 $ 17,242 $ 34,719 $ 23,746 $ 16,415 $ 13,472 $ 403,248 $ 407,363 4.81% 41,762 1.55% 321,064 4.66% 352,601 1.54% 4.65% 11,646 3.30% 309,300 4.61% 349,579 1.01% Loans, net Average rate Securities Average rate Total Financial Assets Average rate Deposits Average rate Federal funds purchased and securities sold under agreements to repurchase 157,601 Average rate Long-term funds Average rate Total Financial Liabilities Average rate 0.16% 50,421 0.62% 560,623 1.43% Loans, net Average rate Securities Average rate Total Financial Assets Average rate Deposits Average rate Federal funds purchased and securities sold under agreements to repurchase 140,102 Average rate Long-term funds Average rate Total Financial Liabilities Average rate 0.42% 40,207 0.77% 529,888 0.91% 6.58% 7,203 3.35% 34,959 6.20% 11,153 1.40% 235 4.61% 11,388 1.61% 6.19% 21,725 1.90% 57,284 5.13% 3,012 2.18% 6.14% 36,278 1.90% 54,985 4.55% 1,915 1.98% 4.96% 42,959 1.69% 64,991 3.65% 2,177 1.98% 235 4.61% 3,247 2.52% 235 4.61% 2,150 2.56% 235 4.61% 2,412 2.51% 5.28% 136,931 3.00% 177,922 3.79% 1,963 4.61% 1,963 4.61% 5.22% 286,858 2.72% 711,205 4.57% 370,858 1.55% 157,601 0.16% 53,324 1.82% 581,783 1.54% 286,932 714,813 372,019 157,601 55,014 581,634 6.12% 1,927 4.39% 19,169 5.99% 20,710 2.38% 223 4.70% 20,933 2.43% 6.53% 22,498 2.04% 57,217 4.77% 1,873 2.46% 6.21% 24,928 2.39% 48,674 5.11% 2,218 2.42% 6.28% 47,202 2.34% 63,617 4.04% 1,479 2.42% 223 4.70% 2,096 2.88% 223 4.70% 2,441 2.79% 223 4.70% 1,702 2.94% 6.09% 187,000 3.37% 200,472 3.68% 3 2.21% 1,858 4.70% 1,861 4.70% 5.19% 295,201 2.79% 698,449 4.56% 375,862 1.34% 140,102 0.42% 42,957 1.93% 558,921 1.17% 295,295 702,658 376,715 140,102 43,990 560,807 7 P E O P L E S F I N A N C I A L C O R P O R A T I O N A N D S U B S I D I A R I E S C O N S O L I D A T E D S T A T E M E N T S O F C O N D I T I O N D E C E M B E R 3 1 , Assets Cash and due from banks Available for sale securities Held to maturity securities, fair value of $1,492,374 - 2011; $2,010,430 - 2010; $3,340,974 - 2009 Other investments Federal Home Loan Bank Stock, at cost Loans Less: Allowance for loan losses Loans, net Bank premises and equipment, net of accumulated depreciation Other real estate Accrued interest receivable Cash surrender value of life insurance Prepaid FDIC assessments Other assets Total assets Liabilities & Shareholders' Equity Liabilities: Deposits: Demand, non-interest bearing Savings and demand, interest bearing Time, $100,000 or more Other time deposits Total deposits Federal funds purchased and securities sold under agreements to repurchase Borrowings from Federal Home Loan Bank Other liabilities Total liabilities Shareholders' Equity: Common Stock, $1 par value, 15,000,000 shares authorized, 5,136,918, 5,151,139, and 5,151,697 shares issued and outstanding at December 31, 2011, 2010 and 2009, respectively Surplus Undivided profits Accumulated other comprehensive income (loss), net of tax Total shareholders' equity 2 0 1 1 2 0 1 0 2 0 0 9 $ 36,928,657 278,918,481 $ 24,146,939 287,078,463 $ 29,155,294 311,434,437 1,428,887 3,930,300 2,580,700 432,407,286 8,135,622 424,271,664 28,035,308 6,153,238 2,698,241 16,196,368 2,096,320 913,926 1,914,879 3,926,371 2,281,200 409,898,757 6,650,258 403,248,499 29,756,239 5,744,150 3,292,430 15,951,117 3,652,972 5,552,225 3,201,966 4,036,304 5,015,900 464,976,291 7,827,806 457,148,485 31,418,884 1,521,313 4,646,752 15,329,394 4,958,309 1,139,861 $ 804,152,090 $ 786,545,484 $ 869,006,899 $ 97,581,073 $ 108,277,985 $ 96,541,387 205,318,859 115,014,220 50,524,930 468,439,082 157,600,967 53,323,568 15,336,172 694,699,789 5,136,918 65,780,254 33,350,861 5,184,268 109,452,301 193,631,209 134,667,660 47,562,661 484,139,515 140,102,019 42,957,016 17,990,072 685,188,622 5,151,139 65,780,254 33,302,381 (2,876,912) 101,356,862 206,167,484 117,347,663 50,644,895 470,701,429 174,430,877 104,270,452 16,016,204 765,418,962 5,151,697 65,780,254 32,853,346 (197,360) 103,587,937 Total liabilities and shareholders' equity $ 804,152,090 $ 786,545,484 $ 869,006,899 See Notes to Consolidated Financial Statements. 8 P E O P L E S F I N A N C I A L C O R P O R A T I O N A N D S U B S I D I A R I E S C O N S O L I D A T E D S T A T E M E N T S O F I N C O M E Y E A R S E N D E D D E C E M B E R 3 1 , 2 0 1 1 2 0 1 0 2 0 0 9 Interest income: Interest and fees on loans Interest and dividends on securities: U.S. Treasuries U.S. Government agencies Mortgage-backed securities States and political subdivisions Other investments Interest on federal funds sold Total interest income Interest expense: Deposits Borrowings from Federal Home Loan Bank Federal funds purchased and securities sold under agreements to repurchase Total interest expense Net interest income Provision for allowance for losses on loans Net interest income after provision for allowance for losses on loans Non-interest income: Trust department income and fees Service charges on deposit accounts Gain on sales and calls of securities Writedown of investments to market value Gain (loss) on other investments Increase in cash surrender value of life insurance Gain on death benefits from life insurance Other income Total non-interest income Non-interest expense: Salaries and employee benefits Net occupancy Equipment rentals, depreciation and maintenance Other expense Total non-interest expense Income (loss) before income taxes Income tax expense (benefit) Net income Basic and diluted earnings per share Dividends declared per share See Notes to Consolidated Financial Statements. 9 $ 17,923,213 $ 19,687,441 $ 20,189,200 235,494 5,320,452 105,905 1,417,445 23,130 6,936 471,051 7,598,366 518,924 1,357,642 26,078 15,263 1,229,237 10,043,869 1,566,573 1,234,917 17,347 8,159 25,032,575 29,674,765 34,289,302 2,353,878 185,925 638,286 3,178,089 21,854,486 2,935,000 18,919,486 1,368,318 5,783,316 1,126,055 96,969 501,268 469,740 514,540 9,860,206 14,083,505 2,350,029 3,332,346 9,014,978 28,780,858 (1,166) (1,204,000) $ 1,202,834 $ .23 $ .19 3,257,391 351,883 991,438 4,600,712 25,074,053 6,845,000 18,229,053 1,354,338 6,103,133 1,690,670 (109,933) 531,283 544,669 10,114,160 13,581,728 2,364,103 3,668,643 7,966,776 27,581,250 761,963 (723,000) $ 1,484,963 $ $ .29 .20 4,965,439 530,082 1,905,383 7,400,904 26,888,398 5,225,000 21,663,398 1,363,489 6,661,209 869,123 (149,517) 146,979 535,342 720,006 10,146,631 14,250,002 2,501,431 3,766,582 7,117,541 27,635,556 4,174,473 954,000 $ 3,220,473 $ .62 $ .30 P E O P L E S F I N A N C I A L C O R P O R A T I O N A N D S U B S I D I A R I E S CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME N u m b e r o f C o m m o n S h a r e s 5,279,268 C o m m o n S t o c k $ 5,279,268 S u r p l u s $ 65,780,254 A c c u m u l a t e d O t h e r U n d i v i d e d C o m p r e h e n s i v e C o m p r e h e n s i v e I n c o m e $ 2,527,996 I n c o m e T o t a l $ 107,000,114 Balance, January 1, 2009 Comprehensive Income: Net income Net unrealized loss on available for sale securities, net of tax Reclassification adjustment for available for sale securities called or sold in current year, net of tax Gain from unfunded post-retirement benefit obligation, net of tax Total comprehensive income Effect of stock retirements on accrued dividends Cash dividends ($ .29 per share) Dividend declared ($ .10 per share) Retirement of stock Balance, December 31, 2009 Comprehensive Income: Net income Net unrealized loss on available for sale securities, net of tax Reclassification adjustment for available for sale securities called or sold in current year, net of tax Loss from unfunded post-retirement benefit obligation, net of tax Total comprehensive loss Cash dividends ($ .11 per share) Dividend declared ($ .09 per share) Retirement of stock Balance, December 31, 2010 Comprehensive Income: Net income Net unrealized gain on available for sale securities, net of tax Reclassification adjustment for available for sale securities called or sold in current year, net of tax Gain from unfunded post-retirement obligation, net of tax Total comprehensive income Cash dividends ($ .09 per share) Dividend declared ($ .10 per share) Retirement of stock Balance, December 31, 2011 See Notes to Consolidated Financial Statements. (127,571) 5,151,697 (127,571) 5,151,697 65,780,254 (197,360) (558) 5,151,139 (558) 5,151,139 65,780,254 (14,221) 5,136,918 (14,221) $ 5,136,918 $ 65,780,254 $ 33,350,861 $ 5,184,268 $ 109,452,301 10 P r o f i t s $ 33,412,596 3,220,473 4,774 (1,030,339) (515,170) (2,238,988) 32,853,346 1,484,963 (566,687) (462,323) (6,918) 33,302,381 1,202,834 (462,323) (513,692) (178,339) $ 3,220,473 (2,392,524) (2,392,524) (474,940) 142,108 (474,940) 142,108 $ 495,117 $ 1,484,963 (1,370,429) (1,370,429) (1,115,842) (193,281) (1,115,842) (193,281) $ (1,194,589) (2,876,912) 5,623,908 (743,196) 3,180,468 $ 1,202,834 5,623,908 (743,196) 3,180,468 $ 9,264,014 3,220,473 (2,392,524) (474,940) 142,108 4,774 (1,030,339) (515,170) (2,366,559) 103,587,937 1,484,963 (1,370,429) (1,115,842) (193,281) (566,687) (462,323) (7,476) 101,356,862 1,202,834 5,623,908 (743,196) 3,180,468 (462,323) (513,692) (192,560) N u m b e r o f C o m m o n S h a r e s 5,279,268 C o m m o n S t o c k $ 5,279,268 S u r p l u s $ 65,780,254 Balance, January 1, 2009 Comprehensive Income: Net income Net unrealized loss on available for sale securities, net of tax Reclassification adjustment for available for sale securities called or sold in current year, net of tax Gain from unfunded post-retirement benefit obligation, net of tax Total comprehensive income Effect of stock retirements on accrued dividends Cash dividends ($ .29 per share) Dividend declared ($ .10 per share) Retirement of stock Balance, December 31, 2009 Comprehensive Income: Net income Net unrealized loss on available for sale securities, net of tax Reclassification adjustment for available for sale securities called or sold in current year, net of tax Loss from unfunded post-retirement benefit obligation, net of tax Total comprehensive loss Cash dividends ($ .11 per share) Dividend declared ($ .09 per share) Retirement of stock Balance, December 31, 2010 Comprehensive Income: Net income Net unrealized gain on available for sale securities, net of tax Reclassification adjustment for available for sale securities called or sold in current year, net of tax Gain from unfunded post-retirement obligation, net of tax Total comprehensive income Cash dividends ($ .09 per share) Dividend declared ($ .10 per share) Retirement of stock Balance, December 31, 2011 See Notes to Consolidated Financial Statements. (127,571) 5,151,697 (127,571) 5,151,697 65,780,254 (558) 5,151,139 (558) 5,151,139 65,780,254 (14,221) 5,136,918 (14,221) $ 5,136,918 U n d i v i d e d P r o f i t s $ 33,412,596 3,220,473 4,774 (1,030,339) (515,170) (2,238,988) 32,853,346 1,484,963 (566,687) (462,323) (6,918) 33,302,381 1,202,834 (462,323) (513,692) (178,339) A c c u m u l a t e d O t h e r C o m p r e h e n s i v e I n c o m e $ 2,527,996 C o m p r e h e n s i v e I n c o m e T o t a l $ 107,000,114 $ 3,220,473 (2,392,524) (2,392,524) (474,940) 142,108 (474,940) 142,108 $ 495,117 (197,360) $ 1,484,963 (1,370,429) (1,370,429) (1,115,842) (193,281) (1,115,842) (193,281) $ (1,194,589) (2,876,912) 5,623,908 (743,196) 3,180,468 $ 1,202,834 5,623,908 (743,196) 3,180,468 $ 9,264,014 3,220,473 (2,392,524) (474,940) 142,108 4,774 (1,030,339) (515,170) (2,366,559) 103,587,937 1,484,963 (1,370,429) (1,115,842) (193,281) (566,687) (462,323) (7,476) 101,356,862 1,202,834 5,623,908 (743,196) 3,180,468 (462,323) (513,692) (192,560) $ 65,780,254 $ 33,350,861 $ 5,184,268 $ 109,452,301 11 P E O P L E S F I N A N C I A L C O R P O R A T I O N A N D S U B S I D I A R I E S C O N S O L I D A T E D S T A T E M E N T S O F C A S H F L O W S Y E A R S E N D E D D E C E M B E R 3 1 , Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation Provision for allowance for losses on loans Write down of other real estate Impairment loss on investments (Gain) loss on other investments Accretion of held to maturity securities Gain on liquidation, sales and calls of securities (Gain) loss on sales of other real estate Gain on death benefits from life insurance Increase in cash surrender value of life insurance Change in accrued interest receivable Change in other assets Change in other liabilities Net cash provided by operating activities Cash flows from investing activities: Proceeds from maturities, sales and calls of available for sale securities Investment in available for sale securities Proceeds from maturities of held to maturity securities Investment in Federal Home Loan Bank stock Redemption of other investments Redemption of Federal Home Loan Bank stock Proceeds from sales of other real estate Loans, net change Acquisition of premises and equipment Proceeds from death benefits from life insurance Investment cash surrender value of life insurance Net cash provided by (used in) investing activities Cash flows from financing activities: Demand and savings deposits, net change Time deposits made, net change Cash dividends Retirement of common stock Borrowings from Federal Home Loan Bank Repayments to Federal Home Loan Bank Federal funds purchased and securities sold under agreements to repurchase, net change Net cash provided by (used in) financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year See Notes to Consolidated Financial Statements. 2 0 1 1 2 0 1 0 2 0 0 9 $ 1,202,834 $ 1,484,963 $ 3,220,473 2,210,000 2,935,000 711,006 (96,969) (2,736) (1,126,055) 180,390 (469,740) (501,268) 594,189 4,061,169 95,700 9,793,520 358,537,612 (341,857,583) 488,728 (299,500) 93,040 1,921,026 (27,179,675) (489,069) 804,883 (79,125) (8,059,663) 990,738 (16,691,171) (924,646) (192,560) 500,974,555 (490,608,003) 17,498,948 11,047,861 12,781,718 24,146,939 2,351,000 6,845,000 77,350 109,933 (2,833) (1,690,670) 86,850 (531,283) 1,354,322 (1,322,873) 1,084,581 9,846,340 403,092,553 (380,565,980) 1,289,920 2,734,700 1,328,000 41,339,949 (688,355) (91,941) 68,438,846 (799,677) 14,237,763 (1,081,857) (7,476) 775,907,492 (837,220,928) (34,328,858) (83,293,541) (5,008,355) 29,155,294 2,390,912 5,225,000 149,517 (146,979) (2,754) (869,123) (150,058) (535,342) 798,015 (3,582,781) 2,975,089 9,471,969 277,022,490 (251,622,168) 195,000 (2,945,200) 3,108,801 (10,192,895) (209,626) (92,294) 15,264,108 (46,314,551) 6,540,444 (2,614,119) (2,366,559) 377,346,745 (310,013,979) (52,178,354) (29,600,373) (4,864,296) 34,019,590 $ 36,928,657 $ 24,146,939 $ 29,155,294 12 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S P E O P L E S F I N A N C I A L C O R P O R A T I O N A N D S U B S I D I A R I E S NN OO TT EE AA -- BB UU SS II NN EE SS SS AA NN DD SS UU MM MM AA RR YY OO FF SS II GG NN II FF II CC AA NN TT AA CC CC OO UU NN TT II NN GG PP OO LL II CC II EE SS :: BBuussiinneessss ooff TThhee CCoommppaannyy Peoples Financial Corporation (the “Company”) is a one-bank holding company headquartered in Biloxi, Mississippi. Its two operating subsidiaries are The Peoples Bank, Biloxi, Mississippi (the “Bank”), and PFC Service Corp. Its principal subsidiary is the Bank, which provides a full range of banking, financial and trust services to state, county and local government entities and individuals and small and commercial businesses operating in those portions of Mississippi, Louisiana and Alabama which are within a fifty mile radius of the Waveland, Wiggins and Gautier branches, the Bank’s three most outlying locations. PPrriinncciipplleess ooff CCoonnssoolliiddaattiioonn The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. BBaassiiss ooff AAccccoouunnttiinngg The Company and its subsidiaries recognize assets and liabilities, and income and expense, on the accrual basis of accounting. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Material estimates common to the banking industry that are particularly susceptible to significant change in the near term include, but are not limited to, the determination of the allowance for loan losses, the valuation of other real estate acquired in connection with foreclosure or in satisfaction of loans, and valuation allowances associated with the realization of deferred tax assets, which are based on future taxable income. NNeeww AAccccoouunnttiinngg PPrroonnoouunncceemmeennttss ASU 2011-01 - Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20(“ASU 2011-01”). ASU 2011-01 temporarily delayed the effective date of the disclosures surrounding troubled debt restructurings in Update 2010-20 for public companies. The Financial Accounting Standards Board (“FASB”) deliberated on what constitutes a troubled debt restructuring and coordinated that guidance with the effective date of the new disclosures, which are effective for interim and annual periods ending after June 15, 2011. It did not have a material impact on the Company’s results of operations, financial position or disclosures. ASU 2011-02 - A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring(“ASU 2011-02”). ASU 2011-02 provides addi- tional guidance to assist creditors in determining whether a restructuring of a receivable meets the criteria to be considered a troubled debt restructuring. ASU 2011-02 is effective for the first interim or annual period beginning on or after June 15, 2011, and is to be applied retrospective- ly to the beginning of the annual period of adoption. As a result of applying ASU 2011-02, an entity may identify receivables that are newly con- sidered impaired. It did not have a material impact on the Company’s results of operations, financial position or disclosures. ASU 2011-04 - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs(“ASU 2011-04”). ASU 2011-04 generally represents clarifications of Topic 820, but also includes some instances where a particular principle or requirement for measur- ing fair value or disclosing information about fair value measurements has changed. ASU 2011-04 results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements. ASU 2011-04 is to be applied prospectively and is effec- tive during interim and annual periods beginning after December 15, 2011 for public companies. It is not expected to have a material impact on the Company’s results of operations, financial position or disclosures. ASU 2011-05 - Amendments to Topic 220, Comprehensive Income(“ASU 2011-05”). ASU 2011-05 grants an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous state- ment of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. ASU 2011-05 does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. For public entities, ASU 2011-05 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, and is to be adopted retrospectively. It is not expected to have a material impact on the Company’s results of operations, financial position or disclosures. ASU 2011-08 – Intangibles – Goodwill and Other (Topic 350) Testing Goodwill for Impairment(“ASU 2011-08”). ASU 2011-08 grants an entity the option to assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. This conclusion can be used as a basis for determining whether it is necessary to perform the two-step goodwill impairment test required in Topic 350. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. It is not expected to have a material impact on the Company’s results of operations, financial position or disclosures. CCaasshh aanndd DDuuee ffrroomm BBaannkkss The Company is required to maintain average reserve balances in its vault or on deposit with the Federal Reserve Bank. The average amount of these reserve requirements was approximately $701,000, $587,000 and $542,000 for the years ending December 31, 2011, 2010 and 2009, respectively. SSeeccuurriittiieess The classification of securities is determined by Management at the time of purchase. Securities are classified as held to maturity when the Company has the positive intent and ability to hold the security until maturity. Securities held to maturity are stated at amortized cost. Securities not classified as held to maturity are classified as available for sale and are stated at fair value. Unrealized gains and losses, net of tax, on these securities are recorded in shareholders’ equity as accumulated other comprehensive income. The amortized cost of available for sale securities and held to maturity securities is adjusted for amortization of premiums and accretion of discounts to maturity, determined using the interest method. Such amortization and accretion is included in interest income on securities. A decline in the market value of any investment below cost that is deemed to be other-than-temporary is charged to earnings for the decline in value deemed to be credit related and a new cost basis in the security is established. The decline in value attrib- uted to non-credit related factors is recognized in other comprehensive income. In estimating other-than-temporary losses, management considers the length of time and the extent to which the fair value has been less than cost, the financial condition and nature of the issuer, the cause of the decline, especially if related to a change in interest rates, and the intent and ability of the Company to retain the investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. The specific identification method is used to determine realized gains and losses on sales of securities, which are reported as gain (loss) on sale and calls of securities in non-interest income. 13 OOtthheerr IInnvveessttmmeennttss Other investments include a low income housing partnership in which the Company is a 99% limited partner. The partnership has qualified to receive annual low income housing federal tax credits that are recognized as a reduction of the current tax expense. The investment is accounted for using the equity method. FFeeddeerraall HHoommee LLooaann BBaannkk SSttoocckk The Company is a member of the Federal Home Loan Bank of Dallas (“FHLB”) and as such is required to maintain a minimum investment in its stock that varies with the level of FHLB advances outstanding. The stock is bought from and sold to the FHLB based on its $100 par value. The stock does not have a readily determinable fair value and as such is classified as restricted stock, carried at cost and evaluated for impairment in accordance with GAAP. LLooaannss The loan portfolio consists of commercial and industrial and real estate loans within the Company’s trade area in South Mississippi, Louisiana and Alabama that we have the intent and ability to hold for the foreseeable future or until maturity. The loan policy establishes guidelines relating to pricing, repayment terms, collateral standards including loan to value limits, appraisal and environmental standards, lending authority, lending limits and documentation requirements. Loans are stated at the amount of unpaid principal, reduced by unearned income and the allowance for loan losses. Interest on loans is recognized on a daily basis over the terms of each loan based on the unpaid principal balance. Loan origination fees are recognized as income when received. Revenue from these fees is not material to the financial statements. The Company continuously monitors its relationships with its loan customers in concentrated industries such as gaming and hotel/motel, as well as the exposure for out of area, land, development, construction and commercial real estate loans, and their direct and indirect impact on its operations. Loan delinquencies and deposit overdrafts are monitored on a monthly basis in order to identify developing problems as early as possible. Also on a monthly basis, a watch list of credits based on our loan grading system is prepared. Grades of A – F are applied to individual loans based on factors including repayment ability, financial condition of the borrower and payment performance. Loans with a grade of D – F, as well as some with a grade of C, are placed on the watch list of credits. The watch list is the primary tool for monitoring the credit quality of the loan portfolio. Once loans are determined to be past due, the loan officer and the loan collection department work vigorously to return the loans to a current status. The Company places loans on a nonaccrual status when, in the opinion of Management, they possess sufficient uncertainty as to timely collection of inter- est or principal so as to preclude the recognition in reported earnings of some or all of the contractual interest. Accrued interest on loans classified as nonaccrual is reversed at the time the loans are placed on nonaccrual. Interest received on nonaccrual loans is applied against principal. Loans are restored to accrual status when the obligation is brought current or has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectibility of the total contractual principal and interest is no longer in doubt. The placement of loans on and removal of loans from nonaccrual status must be approved by Management. Generally, loans which become 90 days delinquent are reviewed relative to collectability. Unless such loans are in the process of terms revision to bring them to a current status or foreclosure or in the process of collection, those loans deemed uncollectible are charged off against the allowance account. That portion of a loan which is deemed uncollectible will be charged off against the allowance as a partial charge off. All charge offs must be approved by Management and are reported to the Board of Directors. AAlllloowwaannccee ffoorr LLooaann LLoosssseess The allowance for loan losses (“ALL”) is a valuation account available to absorb losses on loans. The ALL is established through provisions for loan losses charged against earnings. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses is based on Management’s evaluation of the loan portfolio under current economic conditions and is an amount that Management believes will be adequate to absorb probable losses on loans existing at the reporting date. On a quarterly basis, the Company’s problem asset committee meets to review the watch list of credits, which is formulated from the loan grading system. Members of this committee include loan officers, collection officers, the chief lending officer, the chief credit officer, the credit administration officer, the chief financial officer and the chief executive officer. The evaluation includes Management’s assessment of several factors: review and evaluations of specific loans, changes in the nature and volume of the loan portfolio, current and anticipated economic conditions and the related impact on specific borrowers and industry groups, a study of loss experience, a review of classified, nonperforming and delinquent loans, the estimated value of any underlying collateral, an estimate of the possibility of loss based on the risk characteristics of the portfolio, adverse situations that may affect the borrower’s ability to repay and the results of regulatory examinations. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change. The ALL consists of specific and general components. The specific component relates to loans that are classified as impaired. The general component of the allowance relates to loans that are not impaired. Changes to the components of the ALL are recorded as a component of the provision for loan losses. Management must approve changes to the ALL and must report its actions to the Board of Directors. The Company believes that its allowance for loan loss- es is appropriate at December 31, 2011. The Company considers a loan to be impaired when, based upon current information and events, it believes it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. The Company’s impaired loans include troubled debt restructurings and performing and non-performing major loans for which full payment of principal or interest is not expected. A loan may be impaired but not on nonaccrual status when available information suggests that it is probable that the Bank may not receive all contractual principal and interest, however, the loan is still current and payments are received in accordance with the terms of the loan. Payments received for impaired loans not on nonaccrual status are applied to principal and interest. All impaired loans are reviewed, at a minimum, on a quarterly basis. The Company calculates the specific allowance required for impaired loans based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of its collateral. Most of the Company’s impaired loans are collateral-dependent. The fair value of the collateral for collateral-dependent loans is based on appraisals performed by third-party valuation specialists, comparable sales and other estimates of fair value obtained principally from independent sources such as the Multiple Listing Service or county tax assessment valuations, adjusted for estimated selling costs. The Company has a Real Estate Appraisal Policy (the “Policy”) which is in compliance with the guidelines set forth in the “Interagency Appraisal and Evaluation Guidelines” which implement Title XI of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”) and the revised “Interagency Appraisal and Evaluation Guidelines” issued in 2010. The Policy further requires that appraisals be in writing and conform to the Uniform Standards of Professional Appraisal Practice (“USPAP”). An appraisal prepared by a state-licensed or state-certified appraiser is required on all new loans secured by real estate in excess of $250,000. Loans secured by real estate in an amount of $250,000 or less, or that qualify for an exemption under FIRREA, must have a summary appraisal report or in-house evaluation, depending on the facts and circumstances. Factors including the assumptions and techniques utilized by the appraiser, which could result in a downward adjustment to the collateral value estimates indicated in the appraisal, are considered by the Company. 14 When Management determines that a loan is impaired and the loan is collateral-dependent, an evaluation of the fair value of the collateral is performed. The Company maintains established criteria for assessing whether an existing appraisal continues to reflect the fair value of the property for collateral- dependent loans. Appraisals are generally considered to be valid for a period of at least twelve months. However, appraisals that are less than 12 months old may need to be adjusted. Management considers such factors as the property type, property condition, current use of the property, current market conditions and the passage of time when determining the relevance and validity of the most recent appraisal of the property. If Management determines that the most recent appraisal is no longer valid, a new appraisal is ordered from an independent and qualified appraiser. During the interim period between ordering and receipt of the new appraisal, Management considers if the existing appraisal should be discounted to determine the estimated fair value of collateral. Discounts are applied to the existing appraisal and take into consideration the property type, condition of the property, external market data, internal data, reviews of recently obtained appraisals and evaluations of similar properties, comparable sales of similar properties and tax assessment valuations. When the new appraisal is received and approved by Management, the valuation stated in the appraisal is used as the fair value of the collateral in determining impairment, if any. If the recorded investment in the impaired loan exceeds the measure of fair value, a valuation allowance is required as a specific component of the allowance for loan losses. Any specific reserves recorded in the interim are adjusted accordingly. The general component of the ALL is the loss estimated by applying historical loss percentages to non-classified loans which have been divided into seg- ments. These segments include gaming; residential and land development; real estate, construction; real estate, mortgage; commercial and industrial and all other. The loss percentages are based on each segment’s historical five year average loss experience which may be adjusted by qualitative factors such as changes in the general economy, or economy or real estate market in a particular geographic area or industry. BBaannkk PPrreemmiisseess aanndd EEqquuiippmmeenntt Bank premises and equipment are stated at cost, less accumulated depreciation. Depreciation is computed by the straight-line method based on the estimated useful lives of the related assets. OOtthheerr RReeaall EEssttaattee Other real estate (“ORE”) includes real estate acquired through foreclosure. Each other real estate property is carried at fair value, less estimated costs to sell. Fair value is principally based on appraisals performed by third-party valuation specialists. Any excess of the carrying value of the related loan over the fair value of the real estate at the date of foreclosure is charged against the allowance for loan losses. Any expense incurred in connection with hold- ing such real estate or resulting from any writedowns in value subsequent to foreclosure is included in noninterest expense. When the other real estate property is sold, a gain or loss is recognized on the sale for the difference, if any, between the sales proceeds and the carrying amount of the property. If the fair value of the ORE, less estimated costs to sell at the time of foreclosure, decreases during the holding period, the ORE is written down with a charge to noninterest expense. All ORE properties are being actively marketed for sale and Management is continuously monitoring these properties in order to minimize any losses. TTrruusstt DDeeppaarrttmmeenntt IInnccoommee aanndd FFeeeess Corporate trust fees are accounted for on an accrual basis and personal trust fees are recorded when received. IInnccoommee TTaaxxeess Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Additionally, the recognition of future tax benefits, such as net operating loss carryforwards, is required to the extent that realization of such benefits is more likely than not. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the assets and liabilities are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that includes the enactment date. In the event the future tax consequences of differences between the financial reporting bases and the tax bases of the Company’s assets and liabilities results in deferred tax assets, an evaluation of the probability of being able to realize the future benefits indicated by such asset is required. A valuation allowance is provided for the portion of the deferred tax asset when it is more likely than not that some portion or all of the deferred tax asset will not be realized. In assessing the realizability of the deferred tax assets, management considers the scheduled reversals of deferred tax liabilities, projected future taxable income, and tax planning strategies. The Company currently evaluates income tax positions judged to be uncertain. A loss contingency reserve is accrued if it is probable that the tax position will be challenged, it is probable that the future resolution of the challenge will confirm that a loss has been incurred, and the amount of such loss can be reasonably estimated. PPoosstt--RReettiirreemmeenntt BBeenneeffiitt PPllaann The Company accounts for its post-retirement benefit plan under Accounting Standards Codification (“Codification” or “ASC”) Topic 715, Retirement Benefits, (“ASC 715”). The under or over funded status of the Company’s post-retirement benefit plan is recognized as a liability or asset in the statement of condition. Changes in the plan’s funded status are reflected in other comprehensive income. Net actuarial gains and losses and adjustments to prior service costs that are not recorded as components of the net periodic benefit cost are charged to other comprehensive income. LLeeaasseess All leases are accounted for as operating leases in accordance with the terms of the leases. EEaarrnniinnggss PPeerr SShhaarree Basic and diluted earnings per share are computed on the basis of the weighted average number of common shares outstanding, 5,136,918, 5,151,661 and 5,170,430 in 2011, 2010 and 2009, respectively. AAccccuummuullaatteedd OOtthheerr CCoommpprreehheennssiivvee IInnccoommee At December 31, 2011, 2010 and 2009, accumulated other comprehensive income (loss) consisted of net unrealized gains (losses) on available for sale secu- rities and over (under) funded liabilities related to the Company’s post-retirement benefit plan. SSttaatteemmeennttss ooff CCaasshh FFlloowwss The Company has defined cash and cash equivalents to include cash and due from banks and federal funds sold. The Company paid $3,222,385, $4,621,778 and $7,576,159 in 2011, 2010 and 2009, respectively, for interest on deposits and borrowings. Income tax payments totaled $755,000, $2,232,000 and $520,000 in 2011, 2010 and 2009, respectively. Loans transferred to other real estate amounted to $3,221,510, $5,715,037 and $4,082,874 in 2011, 2010 and 2009, respectively. Unrealized gains (losses) on available for sale securities of $7,395,018, $(3,767,077) and $(4,344,642), net of taxes of $2,514,306, $(1,280,806) and $(1,477,178), were included in accumulated other comprehensive income (loss) at December 31, 2011, 2010 and 2009, respectively. Gains (losses) from the unfunded post-retirement benefit obligation of $4,818,890, $(292,849) and $234,542, net of taxes of $1,638,422, $(99,568) and $92,434, were included in accumulated other comprehensive income (loss) at December 31, 2011, 2010 and 2009, respectively. FFaaiirr VVaalluuee MMeeaassuurreemmeenntt The Company reports certain assets and liabilities at their estimated fair value. These assets and liabilities are classified and disclosed in one of three cat- egories based on the inputs used to develop the measurements. The categories, establish a hierarchy for ranking the quality and reliability of the infor- mation used to determine fair value. 15 RReeccllaassssiiffiiccaattiioonnss Certain reclassifications have been made to the prior year statements to conform to current year presentation. The reclassifications had no effect on prior year net income. NN OO TT EE BB -- SS EE CC UU RR II TT II EE SS :: The amortized cost and fair value of securities at December 31, 2011, 2010, and 2009, respectively, are as follows (in thousands): December 31, 2011 Available for sale securities: Debt securities: U.S. Treasuries U.S. Government agencies Morgage-backed securities States and political subdivisions Total debt securities Equity securities Total available for sale securities Held to maturity securities: States and political subdivisions Total held to maturity securities December 31, 2010 Available for sale securities: Debt securities: U.S. Treasuries U.S. Government agencies States and political subdivisions Total debt securities Equity securities Total available for sale securities Held to maturity securities: States and political subdivisions Total held to maturity securities December 31, 2009 Available for sale securities: Debt securities: U.S. Treasuries U.S. Government agencies Mortgage-backed securities States and political subdivisions Total debt securities Equity securities Total available for sale securities Held to maturity securities: States and political subdivisions Total held to maturity securities Amortized Cost Gross Unrealized Gains Gross Unrealized Losses $ 53,995 176,986 4,727 37,914 273,622 650 $ 274,272 $ $ 1,429 1,429 $ 33 2,220 274 2,163 4,690 $ 4,690 $ 63 $ 63 $ (18) (26) (44) $ (44) $ $ – – Amortized Cost Gross Unrealized Gains Gross Unrealized Losses $ 26,957 221,639 40,579 289,175 650 $ 289,825 $ $ 1,915 1,915 $ 52 1,056 1,114 2,222 $ (500) (4,099) (370) (4,969) $ 2,222 $ (4,969) $ $ 95 95 $ $ – – Amortized Cost Gross Unrealized Gains Gross Unrealized Losses $ 23,987 216,473 30,035 39,291 309,786 650 $ 310,436 $ $ 3,202 3,202 $ 753 695 1,278 1,179 3,905 $ – (2,590) (51) (266) (2,907) $ 3,905 $ (2,907) $ 139 $ 139 $ $ – – Fair Value $ 54,010 179,180 5,001 40,077 278,268 650 $ 278,918 $ $ 1,492 1,492 Fair Value $ 26,509 218,596 41,323 286,428 650 $ 287,078 $ $ 2,010 2,010 Fair Value $ 24,740 214,578 31,262 40,204 310,784 650 $ 311,434 $ $ 3,341 3,341 16 The amortized cost and fair value of debt securities at December 31, 2011, (in thousands) by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Available for sale securities: Due in one year or less Due after one year through five years Due after five years through ten years Due after ten years Mortgage-backed securities Totals Held to maturity securities: Due after one year through five years Due after five years through ten years Totals Amortized Cost $ $ $ $ 41,744 106,341 92,317 28,493 4,727 273,622 1,199 230 1,429 Fair Value $ 41,762 106,966 95,108 29,431 5,001 $ 278,268 $ $ 1,262 230 1,492 Information pertaining to securities with gross unrealized losses at December 31, 2011, 2010 and 2009, respectively, aggregated by investment category and length of time that individual securities have been in a continuous loss position, is as follows (in thousands): Less than twelve months Over twelve months Total December 31, 2011 U.S. Treasuries U.S. Government agencies Total Fair Value Gross Unrealized Losses 18 $ 16,976 26 15,075 44 32,051 $ $ $ Fair Value 15,458 $ Gross Unrealized Losses $ ,458 $ 15,458 $ ,458 Fair Value 16,976 $ 15,075 32,051 $ Gross Unrealized Losses 18 26 $ 44 $ Less than twelve months Over twelve months Total December 31, 2010 U.S. Treasuries U.S. Government agencies States and political subdivisions Total Fair Value 15,458 $ 138,076 5,295 $ 158,829 $ Gross Unrealized Losses 500 4,099 173 $ 4,772 Fair Value 2,826 $ Gross Unrealized Losses $ 826 2,029 2,029 $ 197 197 $ Fair Value 15,458 $ 138,076 7,324 $ 160,858 $ Gross Unrealized Losses 500 4,099 370 $ 4,969 Less than twelve months Over twelve months Total December 31, 2009 U.S. Government agencies States and political subdivisions Mortgage-backed securities Total Fair Value $ 138,914 9,501 4,856 $ 153,271 Gross Unrealized Losses $ 2,590 148 51 $ 2,789 Fair Value 2,826 $ 2,521 Gross Unrealized Losses $ 254 118 $ 2,521 $ 118 Fair Value 138,914 $ 12,022 4,856 $ 155,792 Gross Unrealized Losses $ 2,590 266 51 $ 2,907 At December 31, 2011, 3 of 12 securities issued by the U.S. Treasury and 3 of the 38 securities issued by U.S. Government agencies contained unrealized losses. Management evaluates securities for other-than-temporary impairment on a monthly basis. In performing this evaluation, the length of time and the extent to which the fair value has been less than cost, the fact that the Company’s securities are primarily issued by U.S. Treasury and U.S. Government Agencies and the cause of the decline in value are considered. In addition, the Company does not intend to sell and it is not more likely than not that we will be required to sell these securities before maturity. While some available for sale securities have been sold for liquidity purposes or for gains, the Company has traditionally held its securities, including those classified as available for sale, until maturity. As a result of this evaluation, the Company has determined that the declines summarized in the tables above are not deemed to be other-than-temporary. Proceeds from sales of available for sale debt securities were $60,714,150, $33,993,865 and $89,175,320 during 2011, 2010 and 2009, respectively. Available for sale debt securities were sold and called in 2011, 2010 and 2009 for realized gains of $1,126,055, $1,690,670 and $869,123, respectively. During 2009, the Company recorded a loss of $149,517 from the other-than-temporary impairment of an equity investment. Securities with a fair value of $278,540,119, $283,462,810 and $297,410,477 at December 31, 2011, 2010 and 2009, respectively were pledged to secure public deposits, federal funds purchases and other balances required by law. The value of the Company’s investment in FHLB common stock is determined by the ultimate recoverability of the par value rather than by recognizing temporary declines. The determination of whether the par value will ultimately be recovered is influenced by criteria such as the following: (a) the sig- nificance of the decline in net assets of the FHLB as compared to the capital stock amount and the length of time this situation has persisted, (b) commit- ments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance, (c) the impact of legislative and regulatory changes on the customer base of the FHLB and (d) the liquidity position of the FHLB. While the Federal Home Loan Banks have been negatively impacted by the current economic conditions, the FHLB of Dallas has reported profits, remains in compliance with regulatory capital and liquidity requirements, continues to pay dividends on its stock and make redemptions at par value. With consideration given to these factors, Management concluded that the stock was not impaired at December 31, 2011. 17 NN OO TT EE CC -- LL OO AA NN SS :: The composition of the loan portfolio was as follows (in thousands): December 31, Gaming Residential and land development Real estate, construction Real estate, mortgage Commercial and industrial Other Totals 2011 $ 57,219 29,026 61,042 238,411 33,950 12,759 $ 432,407 2010 $ 44,343 30,064 60,983 222,577 36,464 15,468 $ 409,899 2009 $ 69,938 35,329 59,132 241,601 40,114 18,862 $ 464,976 In the ordinary course of business, the Company’s bank subsidiary extends loans to certain officers and directors and their personal business interests at, in the opinion of Management, the same terms, including interest rates and collateral, as those prevailing at the time for comparable loans of similar cred- it risk with persons not related to the Company or its subsidiaries. These loans do not involve more than normal risk of collectability and do not include other unfavorable features. An analysis of the activity with respect to such loans to related parties is as follows (in thousands): Years Ended December 31, Balance, January 1 January 1 balance, loans of officers and directors appointed during the year New loans and advances Repayments Balance, December 31 2011 $ 5,836 123 2,427 (2,428) $ 5,958 2010 $ 5,815 2009 $ 6,807 2,365 (2,344) $ 5,836 978 (1,970) 5,815 $ As part of its evaluation of the quality of the loan portfolio, Management monitors the Company’s credit concentrations on a monthly basis. Total outstanding concentrations were as follows (in thousands): December 31, Gaming Hotel/motel Out of area 2011 2010 2009 $ 57,219 $ 44,343 $ 69,938 46,956 26,171 47,908 42,790 47,714 46,697 The age analysis of the loan portfolio, segregated by class of loans, as of December 31, 2011, 2010 and 2009, respectively, was as follows (in thousands): Number of Days Past Due 30-59 60-89 Greater Than 90 Total Past Due Current Total Loans Loans Past Due Greater Than 90 Days and Still Accruing December 31, 2011: Gaming Residential and land development Real estate, construction Real estate, mortgage Commercial and industrial Other Total December 31, 2010: Gaming Residential and land development Real estate, construction Real estate, mortgage Commercial and industrial Other Total December 31, 2009: Gaming Residential and land development Real estate, construction Real estate, mortgage Commercial and industrial Other Total $ 2222 $9,205 2,084 13,569 1,536 184 $ 17,373 $ 2222 2,282 8,042 18,480 1,558 274 $30,636 $9˜,205 17,171 2,004 15,090 231 184 $34,680 1,395 2,341 166 23 $3,925 $9,205 4,433 4,640 98 34 $9,205 $9,20 102 2,611 27 55 $2,795 $ Ω 24,161 9,843 28,873 2,090 338 $65,305 $ 2,808 4,599 22,906 28,260 1,697 309 $60,579 $9,205 23,157 2,236 27,026 868 287 $53,574 $57,219 4,865 51,199 209,538 31,860 12,421 $367,102 $41,535 25,465 38,077 194,317 34,767 15,159 $349,320 $ 69,938 12,172 56,896 214,575 39,246 18,575 $ 411,402 $ 57,219 29,026 61,042 238,411 33,950 12,759 $432,407 $ 44,343 30,064 60,983 222,577 36,464 15,468 $409,899 $ 69,938 35,329 59,132 241,601 40,114 18,862 $464,976 $9,205 376 1,314 142 $1,832 $9,205 1,991 955 14 1 $2,961 $9,205 3,560 610 48 $4,218 $ 24,161 6,364 12,963 388 131 $44,007 $ 2,808 2,317 10,431 5,140 41 1 $20,738 $9,205 5,986 130 9,325 610 48 $16,099 18 Ω The Company monitors the credit quality of its loan portfolio through the use of a loan grading system. A score of 1 – 5 is assigned to the loan based on factors including repayment ability, trends in net worth and/or financial condition of the borrower and guarantors, employment stability, management ability, loan to value fluctuations, the type and structure of the loan, conformity of the loan to bank policy and payment performance. Based on the total score, a loan grade of A - F is applied. A grade of A will generally be applied to loans for customers that are well known to the Company and that have excellent sources of repayment. A grade of B will generally be applied to loans for customers that have excellent sources of repayment which have no identifiable risk of collection. A grade of C will generally be applied to loans for customers that have adequate sources of repayment which have little identifiable risk of collection. Loans with a grade of C may be placed on the watch list if weaknesses are not resolved which could result in potential loss or for other circumstances that require monitoring. A grade of D will generally be applied to loans for customers that are inadequately protected by cur- rent sound net worth, paying capacity of the borrower, or pledged collateral. Loans with a grade of D have unsatisfactory characteristics such as cash flow deficiencies, bankruptcy filing by the borrower or dependence on the sale of collateral for the primary source of repayment, causing more than accept- able levels of risk. Loans 60 to 89 days past due receive a grade of D. A grade of E will generally be applied to loans for customers with weaknesses inher- ent in the D classification and in which collection or liquidation in full is questionable. All loans 90 days or more past due are rated E. A grade of F is applied to loans which are considered uncollectible and of such little value that their continuance in an active bank is not warranted. Loans with this grade are charged off, even though partial or full recovery may be possible in the future. All loans 180 days or more past due are rated F and charged off unless the Bank is in the process of collection. An analysis of the loan portfolio by loan grade, segregated by class of loans, as of December 31, 2011, 2010 and 2009, respectively, is as follows (in thousands): December 31, 2011: Gaming Residential and land development Real estate, construction Real estate, mortgage Commercial and industrial Other Total December 31, 2010: Gaming Residential and land development Real estate, construction Real estate, mortgage Commercial and industrial Other Total December 31, 2009: Gaming Residential and land development Real estate, construction Real estate, mortgage Commercial and industrial Other Total A or B $ 41,817 4,865 50,798 197,509 23,972 12,268 $ 331,229 A or B 27,397 25,666 52,417 184,963 33,703 15,232 339,378 A or B 53,797 27,622 53,875 196,408 36,804 18,575 387,081 $ $ $ $ C $9,756 357 2,862 6,551 40 $ 9,810 C $9 ,756 864 315 8,248 289 40 $ 9,756 C $9,75 6 732 12,693 414 56 $13,895 Loans With A Grade Of: D $ 51 3,695 25,870 3,077 384 $ 33,077 Loans With A Grade Of: D $ 6,413 3,102 7,716 25,669 2,323 196 $ 45,419 Loans With A Grade Of: D $ 6,298 1,721 3,515 26,243 2,896 174 $40,847 F $9, 56 $ F $9, 56 E $15,402 24,110 6,192 12,170 350 67 $58,291 E $10,533 432 535 3,697 149 $15,346 $9, 56 E $ 9,843 5,986 1,010 6,257 26 $23,122 F $9756 31 $9 631 $ Total 57,219 29,026 61,042 238,411 33,950 12,759 $ 432,407 Total $ 44,343 30,064 60,983 222,577 36,464 15,468 $ 409,899 Total $ 69,938 35,329 59,132 241,601 40,114 18,862 $ 464,976 Total loans on nonaccrual as of December 31, 2011, 2010 and 2009, respectively, was as follows (in thousands): 2011 December 31, $ 15,402 Gaming 24,110 Residential and land development 6,042 Real estate, construction 11,662 Real estate, mortgage 246 Commercial and Industrial Other 131 $ 57,593 Total 2010 $ 10,222 632 387 3,268 27 1 $ 14,537 2009 $ 9,843 5,386 1,010 5,764 2 $ 22,005 19 During 2011 and 2010, the Company modified certain loans by granting interest rate concessions to these customers. These loans are classified as trou- bled debt restructurings. These loans are all in compliance with their modified terms and are currently accruing. Troubled debt restructurings as of December 31, 2011 and 2010 were as follows (in thousands except for number of contracts): Number of Numbers of Contracts Pre-Modification Outstanding Recorded Investment Post-Modification Outstanding Recorded Investment Related Allowance December 31, 2011: Real estate, construction Real estate, mortgage Commercial and industrial Total December 31, 2010: Real estate, construction Real estate, mortgage Total 3 5 1 9 1 1 2 $ 1,075 9,916 706 $11,697 $186 516 $ 702 $ 1,075 9,916 706 $11,697 $ 186 516 $ 702 Impaired loans, segregated by class of loans, as of December 31, 2011, 2010 and 2009, respectively, were as follows (in thousands): December 31, 2011: With no related allowance recorded: Gaming Residential and land development Real estate, construction Real estate, mortgage Commercial and industrial Other With an allowance recorded: Residential and land development Real estate, construction Real estate, mortgage Commercial and industrial Other Total by class of loans: Gaming Residential and land development Real estate, construction Real estate, mortgage Commercial and industrial Other Total December 31, 2010: With no related allowance recorded: Real estate, mortgage With an allowance recorded: Gaming Residential and land development Real estate, construction Real estate, mortgage Commercial and industrial Other Total by class of loans: Gaming Residential and land development Real estate, construction Real estate, mortgage Commercial and industrial Other Total December 31, 2009: With an allowance recorded: Gaming Residential and land development Real estate, construction Real estate, mortgage Other Total Unpaid Principal Balance Recorded Investment $15,402 24,941 4,743 9,965 864 5 55,920 2,364 2,406 12,552 88 126 17,536 15,402 27,305 7,149 22,517 952 131 $73,456 $1,891 1,891 10,533 4,313 573 2,871 27 1 18,318 10,533 4,313 573 4,762 27 1 $20,209 $9,843 11,085 1,010 6,262 2 $28,202 $15,402 21,746 4,711 9,957 864 5 52,685 2,364 2,406 11,621 88 126 16,605 15,402 24,110 7,117 21,578 952 131 $69,290 $1,843 1,843 10,222 632 573 1,941 27 1 13,396 10,222 632 573 3,784 27 1 $15,239 $9,843 5,386 1,010 5,764 2 $22,005 Related Allowance $3,028 900 720 1,314 77 17 3,028 900 720 1,314 77 17 $3,028 $3,028 107 8 179 649 1 1 945 107 8 179 649 1 1 $945 $98 844 10 942 1 $1,895 No material interest income was recognized on impaired loans for the years ended December 31, 2011, 2010 and 2009, respectively. 20 $ 112 809 $921 $116 110 $226 Average Investment $12,488 7,382 297 1,111 413 21,691 185 5,971 31 6,187 12,488 7,382 482 7,082 413 31 $27,878 $1,116 1,116 9,363 2,693 199 1,251 8 1 13,515 9,363 2,693 199 2,367 8 1 $14,631 $9,512 8,976 1,010 6,052 2 $25,552 Transactions in the allowance for loan losses for the years ended December 31, 2011, 2010 and 2009, respectively, and the balances of loans individually and collectively evaluated for impairment at December 31, 2011, 2010 and 2009, respectively, were as follows (in thousands): December 31, 2011: Allowance for Loan Losses: Beginning Balance Charge-offs Recoveries Provision Ending Balance Allowance for Loan Losses: Ending balance: individually evaluated for impairment Ending balance: collectively evaluated for impairment Total Loans: Ending balance: individually evaluated for impairment Ending balance: collectively evaluated for impairment December 31, 2010: Allowance for Loan Losses: Beginning Balance Charge-offs Recoveries Provision Ending Balance Allowance for Loan Losses: Ending balance: individually evaluated for impairment Ending balance: collectively evaluated for impairment Total Loans: Ending balance: individually evaluated for impairment Ending balance: collectively evaluated for impairment December 31, 2009: Allowance for Loan Losses: Beginning Balance Charge-offs Recoveries Provision Ending Balance Allowance for Loan Losses: Ending balance: individually evaluated for impairment Ending balance: collectively evaluated for impairment Total Loans: Ending balance: individually evaluated for impairment Ending balance: collectively evaluated for impairment Gaming $ 465 35 (43) $ 457 $ 00000 $ 457 $ 15,677 $ 41,542 $ 699 (311) 77 $ 465 $ 00000 $ 465 $ 10,222 $ 34,121 $ 711 (12) $ 699 $ 00000 $ 699 $ 9,843 $60,095 Residential and Land Development Real Estate, Construction Real Estate, Mortgage Commercial and Industrial Other Total $ $ 1,020 (276) 32 161 937 $ 3,413 (1,126) 48 2,465 $ 4,800 $ 480 (95) 24 148 $ 557 $ 202 (175) 84 193 $ 304 $ 6,650 (1,672) 223 2,935 $ 8,136 $ 853 $ 1,953 $ 349 $ 57 $ 4,112 $ 84 $ 2,847 $ 208 $ 247 $ 4,024 $ 9,660 $ 37,988 $ 9,493 $ 3,013 $ 99,941 $51,382 $200,423 $24,457 $ 9,746 $332,466 $ 1,019 (744) 61 684 $ 1,020 $ 3,549 (2,622) 84 2,402 $ 3,413 $ 1,245 (348) 14 (431) $ 480 $ 118 (226) 109 201 $ 202 $ 7,828 (8,291) 268 6,845 $ 6,650 $ 301 $ 1,332 $ 201 $ 9 $ 1,843 $ 719 $ 2,081 $ 279 $ 193 $ 4,807 $ 1,140 $ 7,337 $ 404 $ 12 $ 19,747 $59,843 $215,240 $36,060 $15,456 $390,152 $ 2,438 (417) (1,002) 1,019 $ $ $ 500 519 $ 3,385 (1,576) 77 1,663 $ 3,549 $ 1,479 (104) 85 (215) $ 1,245 $ 338 (405) 407 (222) $ 118 $ 11,114 (9,080) 569 5,225 $ 7,828 $ 1,919 $ 1,015 $ 28 $ 4,271 $ 1,630 $ 230 $ 90 $ 3,557 $ 3,338 $ 10,732 $ 1,128 $ 55 $ 30,482 $55,794 $230,869 $38,986 $18,807 $434,494 $ 1,070 11 $ 1,081 $ 900 $ 181 $ 24,110 $ 4,916 $ 1,198 (4,040) 3,912 $ 1,070 $ 00000 $ 1,070 $ 632 $29,432 $ 2,763 (6,578) 5,013 1,198 $ $ 809 $ 389 $ 5,386 $29,943 21 NN OO TT EE DD -- BB AA NN KK PP RR EE MM II SS EE SS AA NN DD EE QQ UU II PP MM EE NN TT :: Bank premises and equipment are shown as follows (in thousands): December 31, Land Buildings Furniture, fixtures and equipment Totals, at cost Less: Accumulated depreciation Totals Estimated Useful Lives 5 – 40 years 3 – 10 years 2011 $ 5,985 30,494 14,377 50,856 22,821 $ 28,035 2010 $ 5,985 30,359 14,037 50,381 20,625 $ 29,756 2009 $ 5,986 30,233 15,378 51,597 20,178 $ 31,419 NN OO TT EE EE –– OO TT HH EE RR RR EE AA LL EE SS TT AA TT EE :: The Company’s other real estate consisted of the following as of December 31, 2011, 2010 and 2009, respectively (in thousands): December 31, 2010 2011 2009 Construction, land development and other land 1-4 family residential properties Non farm non residential Total Number of Properties 8 8 16 32 Balance $ 1,544 821 3,788 $ 6,153 Number of Properties 11 9 4 24 Balance $1,744 778 3,222 $5,744 Number of Properties 8 8 Balance $ 694 827 16 $1,521 NN OO TT EE FF –– DD EE PP OO SS II TT SS :: At December 31, 2011, the scheduled maturities of time deposits (in thousands) are as follows: $ 147,282 11,153 3,012 1,915 2,177 165,539 2012 2013 2014 2015 2016 Total $ Time deposits of $100,000 or more at December 31, 2011 included brokered deposits of $24,262,000, of which $22,696,000 matures in 2012 and the remain- ing balance matures in 2013. Deposits held for related parties amounted to $7,499,805, $9,448,582 and $9,889,556 at December 31, 2011, 2010 and 2009, respectively. Overdrafts totaling $679,220, $3,027,718 and $740,320 were reclassified as loans at December 31, 2011, 2010 and 2009, respectively. NN OO TT EE GG –– FF EE DD EE RR AA LL FF UU NN DD SS PP UU RR CC HH AA SS EE DD AA NN DD SS EE CC UU RR II TT II EE SS SS OO LL DD UU NN DD EE RR AA GG RR EE EE MM EE NN TT SS TT OO RR EE PP UU RR CC HH AA SS EE :: At December 31, 2011, the Company had facilities in place to purchase federal funds up to $72,900,000 under established credit arrangements. At December 31, 2011, 2010 and 2009, federal funds purchased and securities sold under agreements to repurchase included funds invested by customers in a non- deposit product of the bank subsidiary of $157,600,967, $124,802,000 and $167,280,777, respectively. These accounts are non-insured, non-deposit accounts which allow customers to earn interest on their account with no restrictions as to the number of transactions. They are set up as sweep accounts with no check-writing capabilities and require the customer to have at least one operating deposit account. NN OO TT EE HH –– BB OO RR RR OO WW II NN GG SS :: At December 31, 2011, the Company was able to borrow up to $37,399,199 from the Federal Reserve Bank Discount Window Primary Credit Program. The bor- rowing limit is based on the amount of collateral pledged, with certain loans from the Bank’s portfolio serving as collateral. Borrowings bear interest at 25 basis points over the current fed funds rate and have a maturity of one day. There was no outstanding balance at December 31, 2011. At December 31, 2011, the Company had $53,323,568 outstanding in advances under a $118,212,202 line of credit with the Federal Home Loan Bank of Dallas (“FHLB”). One advance in the amount of $19,000,000 bears interest at a fixed rate of .12%. One advance in the amount of $10,000,000 bears interest at a fixed rate of .14%. Two advances totaling $20,000,000 bear interest at .12%. One advance in the amount of $1,200,000 bears interest at a fixed rate of .20%. All of these advances mature in 2012. The remaining balance consists of smaller advances bearing interest from 3.04% to 7.00% with maturity dates from 2015 – 2042. The advances are collateralized by a blanket floating lien on the Company’s residential first mortgage loans which totaled $58,903,986 at December 31,2011. NN OO TT EE II –– NN OO TT EE SS PP AA YY AA BB LL EE :: The Company had a $5,000,000 unsecured line of credit with Silverton Bank, N.A. The line bore interest at .50% under Wall Street Journal Prime and required interest only payments quarterly with all principal and accrued interest due at maturity, which was July 6, 2009. The Company had a $2,500,000 unsecured line of credit with Mississippi National Bankers Bank. The line bore interest at Wall Street Journal Prime with a floor of 4.00% and required inter- est only payments quarterly with all principal and accrued interest due at maturity, which was March 11, 2010. 22 NN OO TT EE JJ -- II NN CC OO MM EE TT AA XX EE SS :: Deferred taxes (or deferred charges) as of December 31, 2011, 2010 and 2009, included in other assets or other liabilities, were as follows (in thousands): December 31, Deferred tax assets: Allowance for loan losses Employee benefit plans' liabilities Unrealized loss on available for sale securities charged from equity Earned retiree health benefits plan liability Unearned retiree health benefits plan liability Other Deferred tax assets Deferred tax liabilities: Unrealized gain on available for sale securities, charged to equity Unearned retiree health benefit plan asset Bank premises and equipment Other Deferred tax liabilities Net deferred taxes Income taxes consist of the following components (in thousands): Years Ended December 31, Current Deferred Totals 2011 2010 2009 $ 2,777 $ 2,261 $ 2,661 3,846 1,673 781 9,077 1,580 1,086 5,720 343 8,729 3,368 934 1,454 364 423 8,804 6,071 370 6,441 3,005 1,225 299 540 7,730 339 6,547 489 7,375 $ 348 $ 2,363 √$ 355 2011 2010 2009 $ 721 $ (119) $ (208) (1,925) (604) 1,162 $ (1,204) $ (723) $ 954 Income taxes amounted to less than the amounts computed by applying the U.S. Federal income tax rate of 34.0% for 2011, 2010 and 2009 to earnings before income taxes. The reason for these differences is shown below (in thousands): Years Ended December 31, Taxes computed at statutory rate Increase (decrease) resulting from: Tax-exempt interest income Increase in cash surrender value Federal tax credits Deferred expense adjustment Death benefits on life insurance Other 2011 Amount $ (1) % 34.0 2010 Amount $ 259 % 34.0 2009 Amount $ 1,419 (557) (170) (366) (159) 49 (428) (181) (366) (56.2) (23.8) (48.1) (385) (183) (129) 228 (7) (0.9) 4 Total income tax expense (benefit) $ (1,204) $ (723) (95.0) $ º954 % 34.0 (9.2) (4.4) (3.1) 5.5 0.1 22.9 The Company has reviewed its income tax positions and specifically considered the recognition and measurement requirements of the benefits recorded in its financial statements for tax positions taken or expected to be taken in its tax returns. Based on its evaluation of these tax positions for its open tax years, the Company believes that it is more likely than not we will realize the net deferred tax asset and it has not recorded any tax liability for uncertain tax positions as of December 31, 2011, 2010 and 2009. NN OO TT EE KK -- SS HH AA RR EE HH OO LL DD EE RR SS ’’ EE QQ UU II TT YY :: Shareholders’ equity of the Company includes the undistributed earnings of the bank subsidiary. Dividends to the Company’s shareholders can generally be paid only from dividends paid to the Company by its bank subsidiary. Consequently, dividends are dependent upon the earnings, capital needs, regulatory policies and statutory limitations affecting the bank subsidiary. Dividends paid by the bank subsidiary are subject to the approval of the Commissioner of Banking and Consumer Finance of the State of Mississippi and the Federal Deposit Insurance Corporation. At December 31, 2011, approximately $24,162,449 of undistributed earnings of the bank subsidiary included in consolidated surplus and retained earnings was available for future distribution to the Company as dividends. Dividends paid by the Company are subject to the approval of the Federal Reserve Bank (“FRB”). On September 24, 2008, the Board approved the repurchase of up to 2.50% of the outstanding shares of the Company’s common stock. As a result of this repurchase plan, which was completed during 2009, 132,588 shares were repurchased and retired. On February 25, 2009, the Board approved the repur- chase of up to 3% of the outstanding shares of the Company’s common stock. As a result of this repurchase plan, 34,024 shares were repurchased and retired as of December 31, 2011. 23 On December 28, 2011, the Company’s Board of Directors approved a semi-annual dividend of $.10 per share. This dividend has a record date of January 10, 2012 and a distribution date of January 17, 2012. The bank subsidiary is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capi- tal requirements can initiate certain mandatory, and possibly additional discretionary, actions by the regulators that, if undertaken, could have a direct material effect on the bank subsidiary’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the bank subsidiary must meet specific capital guidelines that involve quantitative measures of the bank subsidiary’s assets, liabilities and cer- tain off-balance sheet items as calculated under regulatory accounting practices. The bank subsidiary’s capital amounts and classification are also sub- ject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the bank subsidiary to maintain minimum amounts and ratios of Total and Tier 1 capital to risk-weighted assets, and Tier 1 capital to average assets. As of December 31, 2011, the most recent notification from the Federal Deposit Insurance Corporation categorized the bank subsidiary as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the bank subsidiary must have a Total risk-based cap- ital ratio of 10.00% or greater, a Tier 1 risk-based capital ratio of 6.00% or greater and a Leverage capital ratio of 5.00% or greater. There are no conditions or events since that notification that Management believes have changed the bank subsidiary’s category. The Company’s actual capital amounts and ratios and required minimum capital amounts and ratios for 2011, 2010 and 2009, are as follows (in thousands): December 31, 2011: Total Capital (to Risk Weighted Assets) Tier 1 Capital (to Risk Weighted Assets) Tier 1 Capital (to Average Assets) December 31, 2010: Total Capital (to Risk Weighted Assets) Tier 1 Capital (to Risk Weighted Assets) Tier 1 Capital (to Average Assets) December 31, 2009: Total Capital (to Risk Weighted Assets) Tier 1 Capital (to Risk Weighted Assets) Tier 1 Capital (to Average Assets) Actual Amount $ 110,762 104,116 104,116 $ 110,435 104,233 104,233 $ 111,060 103,785 103,785 Ratio 20.86% 19.61% 12.84% 22.26% 21.01% 12.40% 19.08% 17.83% 11.47% For Capital Adequacy Purposes Ratio Amount $42,475 21,238 32,436 $39,691 19,846 33,616 $46,559 23,280 36,194 8.00% 4.00% 4.00% 8.00% 4.00% 4.00% 8.00% 4.00% 4.00% The bank subsidiary’s actual capital amounts and ratios and required minimum capital amounts and ratios for 2011, 2010 and 2009, are as follows (in thousands): Actual Amount Ratio For Capital Adequacy Purposes Amount Ratio To Be Well Capitalized Ratio Amount December 31, 2011: Total Capital (to Risk Weighted Assets) Tier 1 Capital (to Risk Weighted Assets) Tier 1 Capital (to Average Assets) December 31, 2010: Total Capital (to Risk Weighted Assets) Tier 1 Capital (to Risk Weighted Assets) Tier 1 Capital (to Average Assets) December 31, 2009: Total Capital (to Risk Weighted Assets) Tier 1 Capital (to Risk Weighted Assets) Tier 1 Capital (to Average Assets) $ 108,149 101,503 101,503 20.40% 19.15% 12.56% $ 105,255 99,111 99,111 $ 105,728 98,512 98,512 21.41% 20.16% 11.86% 18.31% 17.06% 10.94% $42,413 21,207 32,332 $39,320 19,660 33,431 $46,184 23,092 36,006 8.00% 4.00% 4.00% 8.00% 4.00% 4.00% 8.00% 4.00% 4.00% $53,014 31,809 40,407 49,162 29,497 41,784 57,743 34,646 45,024 10.00% 6.00% 5.00% 10.00% 6.00% 5.00% 10.00% 6.00% 5.00% 24 NN OO TT EE LL -- OO TT HH EE RR II NN CC OO MM EE AA NN DD EE XX PP EE NN SS EE SS :: Other income consisted of the following (in thousands): Years Ended December 31, Other service charges, commissions and fees Rentals Other Totals Other expenses consisted of the following (in thousands): Years Ended December 31, Advertising Data processing FDIC and state banking assessments Legal and accounting Other real estate ATM expense Trust expense Other Totals 2011 $ 78 392 45 $ 515 2011 $ 506 858 1,688 600 1,350 1,973 331 1,709 $ 9,015 2010 $ 84 400 61 $ 545 2010 $ 580 567 1,510 839 411 2,024 298 1,738 $7,967 2009 $ 83 484 153 $ 720 2009 $ 583 380 1,429 518 161 2,038 326 1,683 $ 7,118 NN OO TT EE MM -- FF II NN AA NN CC II AA LL II NN SS TT RR UU MM EE NN TT SS WW II TT HH OO FF FF -- BB AA LL AA NN CC EE -- SS HH EE EE TT RR II SS KK :: The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and irrevocable letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract amounts of those instruments reflect the extent of involvement the bank subsidiary has in particular classes of financial instruments. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and irrevocable letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any conditions established in the agreement. Irrevocable letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Commitments and irrevocable letters of credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments and irrevocable letters of credit may expire without being drawn upon, the total amounts do not necessarily represent future cash requirements. The Company evaluated each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on Management’s credit evaluation of the customer. Collateral obtained varies but may include equipment, real property and inventory. The Company generally grants loans to customers in its primary trade area of Harrison, Hancock, Jackson and Stone counties. At December 31, 2011, 2010 and 2009, the Company had outstanding irrevocable letters of credit aggregating $3,094,258, $4,564,004 and $6,037,976, respectively. At December 31, 2011, 2010 and 2009, the Company had outstanding unused loan commitments aggregating $76,421,050, $110,667,857 and $97,882,869, respectively. Approximately $42,051,000, $71,244,000 and $63,298,000 of outstanding commitments were at fixed rates and the remainder were at variable rates at December 31, 2011, 2010 and 2009, respectively. NN OO TT EE NN -- CC OO NN TT II NN GG EE NN CC II EE SS :: The bank is involved in various legal matters and claims which are being defended and handled in the ordinary course of business. None of these matters is expected, in the opinion of Management, to have a material adverse effect upon the financial position or results of operations of the Company. 25 NN OO TT EE OO -- CC OO NN DD EE NN SS EE DD PP AA RR EE NN TT CC OO MM PP AA NN YY OO NN LL YY FF II NN AA NN CC II AA LL II NN FF OO RR MM AA TT II OO NN :: Peoples Financial Corporation began its operations September 30, 1985, when it acquired all the outstanding stock of The Peoples Bank, Biloxi, Mississippi. A condensed summary of its financial information is shown below. C O N D E N S E D B A L A N C E S H E E T S ( I N T H O U S A N D S ) : December 31, Assets Investments in subsidiaries, at underlying equity: Bank subsidiary Nonbank subsidiary Cash in bank subsidiary Other assets Total assets Liabilities and Shareholders' Equity Other liabilities Total liabilities Shareholders' equity Total liabilities and shareholders' equity 2011 2010 2009 $ 104,731 $ 96,386 $ 98,467 1 808 4,588 1 957 4,637 1 1,103 4,694 $ 110,128 $ 101,981 $ 104,265 $ 676 676 109,452 $ 110,128 $ 624 624 101,357 $ 101,981 $ 677 677 103,588 $ 104,265 C O N D E N S E D S T A T E M E N T S O F I N C O M E ( I N T H O U S A N D S ) : Years Ended December 31, Income Earnings of bank subsidiary: Distributed earnings Undistributed earnings Other income Total income Expenses Other Total expenses Income before income taxes Income tax (benefit) Net income 2011 2010 2009 $ 898 $ 1,000 $ 5,800 285 110 1,293 95 95 1,198 (5) 599 (96) 1,503 71 71 1,432 (53) (2,511) 7 3,296 71 71 3,225 5 $ 1,203 $ 1,485 $ 3,220 26 C O N D E N S E D S T A T E M E N T S O F C A S H F L O W S ( I N T H O U S A N D S ) : Years Ended December 31, Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: (Gain) loss on other investments Impairment loss on equity investments Undistributed income of consolidated subsidiaries Change in assets and liabilities: Other assets Net cash provided by operating activities Cash flows from investing activities: Investment in equity securities Redemption of equity securities Net cash provided (used in) by investing activities Advances on line of credit Principal payments on line of credit Retirement of stock Dividends paid Net cash used in financing activities Net increase (decrease) in cash Cash, beginning of year Cash, end of year 2011 2010 2009 $ 1,203 $ 1,485 $ 3,220 (97) (285) 54 875 93 93 (193) (924) 110 (599) (53) 943 – – – (7) (1,082) (147) 150 2,510 5 5,738 (150) (150) 1,500 (1,500) (2,367) (2,614) $ (1,117) $ (1,089) $ (4,981) (149) 957 (146) 1,103 607 496 $ 808 $ 957 $ 1,103 Peoples Financial Corporation paid income taxes of $755,000, $2,232,000 and $520,000 in 2011, 2010 and 2009, respectively. No interest was paid during the three years ended December 31, 2011. NN OO TT EE PP -- EE MM PP LL OO YY EE EE BB EE NN EE FF II TT PP LL AA NN SS :: The Company sponsors the Peoples Financial Corporation Employee Stock Ownership Plan (“ESOP”). Employees who are in a position requiring at least 1,000 hours of service during a plan year and who are 21 years of age are eligible to participate in the ESOP. The Plan included 401(k) provisions and the former Gulf National Bank Profit Sharing Plan. Effective January 1, 2001, the ESOP was amended to separate the 401(k) funds into the Peoples Financial Corporation 401(k) Profit Sharing Plan. The separation had no impact on the eligibility or benefits provided to participants of either plan. The 401(k) provides for a matching contribution of 75% of the amounts contributed by the employee (up to 6% of compensation). Contributions are determined by the Board of Directors and may be paid either in cash or Peoples Financial Corporation capital stock. Total contributions to the plans charged to operating expense were $270,000, $380,000 and $400,000 in 2011, 2010 and 2009, respectively. Compensation expense of $8,426,829, $8,548,297 and $9,091,240 was the basis for determining the ESOP contribution allocation to participants for 2011, 2010 and 2009, respectively. The ESOP held 429,158, 441,316 and 445,884 allocated shares at December 31, 2011, 2010 and 2009, respectively. The Company established an Executive Supplemental Income Plan and a Directors’ Deferred Income Plan, which provide for pre-retirement and post- retirement benefits to certain key executives and directors. Benefits under the Executive Supplemental Income Plan are based upon the position and salary of the officer at retirement or death. Normal retirement benefits under the plan are equal to 67% of salary for the president and chief executive officer, 58% of salary for the executive vice president and 50% of salary for all other executive officers and are payable monthly over a period of fifteen years. Under the Directors’ Deferred Income Plan, the directors are given an opportunity to defer receipt of their annual directors’ fees until age sixty-five. For those who choose to participate, benefits are payable monthly for ten years beginning the first day of the month following the director’s normal retire- ment date. The normal retirement date is the later of the normal retirement age (65) or separation of service. Interest on deferred fees accrues at an annu- al rate of ten percent, compounded annually. The Company has acquired insurance policies, with the bank subsidiary as owner and beneficiary, which it may use as a source to pay potential benefits to the plan participants. These contracts are carried at their cash surrender value, which amounted to $14,833,939, $14,667,545 and $14,167,091 at December 31, 2011, 2010 and 2009, respectively. The present value of accumulated benefits under these plans, using an interest rate of 5.25% in 2011 and 6.00% in 2010 and 2009 and the interest ramp-up method in 2011, 2010 and 2009, has been accrued. The accru- al amounted to $9,764,957, $8,723,365 and $7,768,888 at December 31, 2011, 2010 and 2009, respectively, and is included in Other Liabilities. 27 The Company also has additional plans for non-vested post-retirement benefits for certain key executives. The Company has acquired insurance policies, with the bank sub- sidiary as owner and beneficiary, which it may use as a source to pay potential benefits to the plan participants. These contracts are carried at their cash surrender value, which amounted to $997,133, $890,086 and $793,434 at December 31, 2011, 2010 and 2009, respectively. The present value of accumulated benefits under these plans using an inter- est rate of 5.25% in 2011 and 6.00% in 2010 and 2009, and the projected unit cost method has been accrued. The accrual amounted to $1,314,727, $936,566 and $835,249 at December 31, 2011, 2010 and 2009, respectively, and is included in Other Liabilities. Additionally, there are two endorsement split dollar policies, with the bank subsidiary as owner and beneficiary, which provide a guaranteed death ben- efit to the participants’ beneficiaries. These contracts are carried at their cash surrender value, which amounted to $255,166, $248,087 and $241,059 at December 31, 2011, 2010 and 2009, respectively. The present value of accumulated benefits under these plans using an interest rate of 6.00% in 2011, 2010 and 2009 and the projected unit cost method has been accrued. The accrual amounted to $78,142, $73,602 and $66,717 at December 31, 2011, 2010 and 2009, respectively, and is included in Other Liabilities. The Company has additional plans for non-vested post-retirement benefits for directors. The Company has acquired insurance policies, with the bank subsidiary as owner and beneficiary, which it may use as a source to pay potential benefits to the plan participants. These contracts are carried at their cash surrender value, which amounted to $118,787, $139,703 and $127,810 at December 31, 2011, 2010 and 2009, respectively. The present value of accumu- lated benefits under these plans using an interest rate of 5.25% in 2011 and 6.00% in 2010 and 2009, and the projected unit cost method has been accrued. The accrual amounted to $152,781, $172,199 and $163,173 at December 31, 2011, 2010 and 2009, respectively, and is included in Other Liabilities. The Company provides post-retirement health insurance to certain of its retired employees. Employees are eligible to participate in the retiree health plan if they retire from active service no earlier than their Social Security normal retirement age, which varies from 65 to 67 based on the year of birth. In addi- tion, the employee must have at least 25 continuous years of service with the Company immediately preceding retirement. However, any active employ- ee who was at least age 65 as of January 1, 1995, does not have to meet the 25 years of service requirement. The accumulated post-retirement benefit obli- gation at January 1, 1995, was $517,599, which the Company elected to amortize over 20 years. The Company reserves the right to modify, reduce or elim- inate these health benefits. The Company has chosen to not offer this post-retirement benefit to individuals entering the employ of the Company after December 31, 2006. In 2011, the Company offered a voluntary early retirement program to employees who, as of December 31, 2011, were between the ages of 55 and 64 and had at least 25 continuous years of service. Eight employees accepted the package, which resulted in special termination benefits for the retiree health plan of $459,064 for 2011. Effective January 1, 2012, the Company amended the retiree health plan. The amendment requires that employees who are eligible and enroll in the bank subsidiary’s group medical and dental health care plans upon their retirement must enroll in Medicare Parts A, B and D upon their retirement from the bank subsidiary. This results in the bank subsidiary’s programs being secondary insurance coverage for retired employees and any dependent(s), if applicable, while Medicare Parts A and B will be their primary coverage, and Medicare Part D will be the sole and exclusive prescription drug benefit plan for retired employees. This amendment reduced the accumulated post-retirement benefit obligation by $3,799,308 as of December 31, 2011. The following is a summary of the components of the net periodic post-retirement benefit cost: Years Ended December 31, 2011 2010 Service cost, including amortization of loss $ 330,184 $ 411,915 Interest cost Amortization of net transition obligation Special termination benefit 222,440 20,600 459,064 276,293 20,600 2009 $ 396,918 245,511 20,600 Net periodic post-retirement benefit cost $ 1,032,288 $ 708,808 $ 663,029 The discount rate used in determining the accumulated post-retirement benefit obligation was 4.50% in 2011, 5.60% in 2010 and 6.05% in 2009. The assumed health care cost trend rate used in measuring the accumulated post-retirement benefit obligation was 8.00% in 2010. The rate was assumed to decrease gradually to 5.00% for 2016 and remain at that level thereafter. If the health care cost trend rate assumptions were increased 1.00%, the accumu- lated post-retirement benefit obligation as of December 31, 2011, would be increased by 13.34 %, and the aggregate of the service and interest cost com- ponents of the net periodic post-retirement benefit cost for the year then ended would have increased by 22.51%. If the health care cost trend rate assump- tions were decreased 1.00%, the accumulated post-retirement benefit obligation as of December 31, 2011, would be decreased by 10.75%, and the aggre- gate of the service and interest cost components of the net periodic post-retirement benefit cost for the year then ended would have decreased by 16.97%. The following table presents the estimated benefit payments for each of the next five years and in the aggregate for the next five years: Year 2012 2013 2014 2015 2016 2017 – 2021 $135,000 142,000 148,000 145,000 121,000 349,000 The following is a reconciliation of the accumulated post-retirement benefit obligation, which is included in Other Liabilities: Accumulated post-retirement benefit obligation as of December 31, 2010 Service cost Interest cost Actuarial gain Special termination benefit Plan changes Benefits paid Accumulated post-retirement benefit obligation as of December 31, 2011 $ 5,533,058 292,942 222,440 (961,319) 459,064 (3,799,308) (75,666) 1,671,211 $ 28 The following is a summary of the change in plan assets: Fair value of plan assets at beginning of year Actual return on assets Employer contribution Benefits paid, net Fair value of plan assets at end of year Amounts recognized in the Accumulated Other Comprehensive Income (Loss), net of tax, were: For the year ended December 31, Net gain (loss) Transition obligation Prior service charge (cost) Total accumulated other comprehensive income 2011 2010 2009 $ $ 75,666 (75,666) $ $ 67,486 (67,486) $ $ 57,257 (57,257) 2011 2010 2009 $ 255,873 1,851,871 $2,107,744 $ (348,127) (54,382) (669,936) $(1,072,445) $ (86,201) (67,965) (724,998) $ (879,164) Amounts recognized in the accumulated post-retirement benefit obligation and other comprehensive income were: For the year ended December 31, Unrecognized actuarial gain Amortization of prior service cost Amortization of transition obligation Total accumulated other comprehensive income 2011 $ 915,152 3,820,919 82,397 $4,818,468 The estimated net gain and prior service credit for the other postretirement plan that will be recognized in accumulated other comprehensive income dur- ing 2012 is $16,006 and $203,619, respectively. NN OO TT EE QQ -- FF AA II RR VV AA LL UU EE MM EE AA SS UU RR EE MM EE NN TT SS AA NN DD DD II SS CC LL OO SS UU RR EE SS :: The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Available for sale securities are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a non-recurring basis, such as impaired loans and ORE. These non-recurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets. Additionally, the Company is required to disclose, but not record, the fair value of other financial instruments. FFaaiirr VVaalluuee HHiieerraarrcchhyy The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliabil- ity of the assumptions used to determine fair value. These levels are: Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets. Level 2 –Valuation is based upon quoted market prices for similar instruments in active markets, quoted prices for identical or similar instruments in mar- kets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Level 3 –Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobserv- able assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques. Following is a description of valuation methodologies used for assets recorded at fair value. The Company does not record any liabilities at fair value. CCaasshh aanndd DDuuee ffrroomm BBaannkkss The carrying amount shown as cash and due from banks approximates fair value. AAvvaaiillaabbllee ffoorr SSaallee SSeeccuurriittiieess The fair value of available for sale securities is based on quoted market prices. The Company’s available for sale securities are reported at their estimated fair value, which is determined utilizing several sources. The primary source is Interactive Data Corporation, which utilizes pricing models that vary based by asset class and include available trade, bid and other market information and whose methodology includes broker quotes, proprietary models and vast descriptive databases. The other source for determining fair value is matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark securities. All of the Company’s available for sale securities are Level 2 assets. HHeelldd ttoo MMaattuurriittyy SSeeccuurriittiieess The fair value of held to maturity securities is based on quoted market prices. OOtthheerr IInnvveessttmmeennttss The carrying amount shown as Other Investments approximates fair value. FFeeddeerraall HHoommee LLooaann BBaannkk SSttoocckk The carrying amount shown as Federal Home Loan Bank Stock approximates fair value. LLooaannss The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to bor- rowers with similar credit ratings for the remaining maturities. The cash flows considered in computing the fair value of such loans are segmented into categories relating to the nature of the contract and collateral based on contractual principal maturities. Appropriate adjustments are made to reflect probable credit losses. Cash flows have not been adjusted for such factors as prepayment risk or the effect of the maturity of balloon notes. The fair value of floating rate loans is estimated to be its carrying value. At each reporting period, the Company determines which loans are impaired. Accordingly, the Company’s impaired loans are reported at their estimated fair value on a non-recurring basis. An allowance for each impaired loan, which are generally collateral-dependent, is calculated based on the fair value of its collateral. The fair value of the collateral is based on appraisals performed by third-party 29 valuation specialists. Factors including the assumptions and techniques utilized by the appraiser are considered by Management. If the recorded invest- ment in the impaired loan exceeds the measure of fair value of the collateral, a valuation allowance is recorded as a component of the allowance for loan losses. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as a non-recurring Level 2 asset. When an appraised value is not available or Management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as a non-recurring Level 3 asset. OOtthheerr RReeaall EEssttaattee In the course of lending operations, Management may determine that it is necessary to foreclose on the related collateral. Other real estate acquired through foreclosure is carried at fair value, less estimated costs to sell. The fair value of the collateral is based on appraisals performed by third-party val- uation specialists. Factors including the assumptions and techniques utilized by the appraiser are considered by Management. If the current appraisal is more than one year old and/or the loan balance is more than $200,000, a new appraisal is obtained. Otherwise, the Bank’s in-house property evaluator and management will determine the fair value of the collateral, based on comparable sales, market conditions, Management’s plans for disposition and other estimates of fair value obtained from principally independent sources, adjusted for estimated selling costs. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the other real estate as a non-recurring Level 2 asset. When an appraised value is not available or Management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the other real estate as a non-recurring Level 3 asset. CCaasshh SSuurrrreennddeerr VVaalluuee ooff LLiiffee IInnssuurraannccee The carrying amount of cash surrender value of bank-owned life insurance approximates fair value. DDeeppoossiittss The fair value of non-interest bearing demand and interest bearing savings and demand deposits is the amount reported in the financial statements. The fair value of time deposits is estimated by discounting the cash flows using current rates of time deposits with similar remaining maturities. The cash flows considered in computing the fair value of such deposits are based on contractual maturities, since approximately 98% of time deposits provide for auto- matic renewal at current interest rates. FFeeddeerraall FFuunnddss PPuurrcchhaasseedd aanndd SSeeccuurriittiieess SSoolldd uunnddeerr AAggrreeeemmeennttss ttoo RReeppuurrcchhaassee The carrying amount shown as federal funds purchased and securities sold under agreements to repurchase approximates fair value. BBoorrrroowwiinnggss ffrroomm FFeeddeerraall HHoommee LLooaann BBaannkk The fair value of FHLB fixed rate borrowings is estimated using discounted cash flows based on current incremental borrowing rates for similar types of borrowing arrangements. The Company has no FHLB variable rate borrowings. CCoommmmiittmmeennttss ttoo EExxtteenndd CCrreeddiitt aanndd SSttaannddbbyy LLeetttteerrss ooff CCrreeddiitt Because commitments to extend credit and standby letters of credit are generally short-term and at variable rates, the contract value and estimated value associated with these instruments are immaterial. The balances of available for sale securities, which are the only assets measured at fair value on a recurring basis, by level within the fair value hierarchy and by investment type, as of December 31, 2011, 2010 and 2009 were as follows (in thousands): December 31, 2011 U.S. Treasuries U.S. Government agencies Mortgage-backed securities States and political subdivisions Equity securities Total December 31, 2010 U.S. Treasuries U.S. Government agencies States and political subdivisions Equity securities Total December 31, 2009 U.S. Treasuries U.S. Government agencies Mortgage-backed securities States and political subdivisions Equity securities Total Fair Value Measurements Using Level 2 $ 54,010 179,180 5,001 40,077 650 $278,918 Fair Value Measurements Using Level 2 $ 26,509 218,596 41,323 650 $287,078 Fair Value Measurements Using Level 2 $ 24,740 214,578 31,262 40,204 650 $ 311,434 Level 1 $287,078 $287,078 Level 1 $287,078 $287,078 Level 1 $287,078 $287,078 Level 3 $287,078 $287,078 Level 3 $287,078 $287,078 Level 3 $287,078 $287,078 Total $ 54,010 179,180 5,001 40,077 650 $278,918 Total $ 26,509 218,596 41,323 650 $287,078 Total $ 24,740 214,578 31,262 40,204 650 $ 311,434 30 Impaired loans, which are measured at fair value on a non-recurring basis, by level within the hierarchy as of December 31, 2011, 2010 and 2009 were as follows (in thousands): December 31: 2011 2010 2009 Total $ 66,262 14,295 20,110 Level 1 $287,078 87,078 Fair Value Measurements Using Level 2 $287,078 87,078 287,07820 Level 3 $ 66,262 14,295 20,110 The following table sets forth a summary of changes in the fair value of impaired loans which are measured using level 3 inputs (in thousands): For the year ended December 31, Balance, beginning of year Additions to impaired loans and troubled debt restructurings Principal payments, charge-offs and transfers to other real estate Change in allowance for loan losses on impaired loans Balance, end of year 2011 2010 $ 20,110 $ 14,295 61,165 5,519 (7,115) (12,286) 952 (2,083) $ 14,295 $ 66,262 Other real estate, which is measured at fair value on a non-recurring basis, by level within the hierarchy as of December 31, 2011, 2010 and 2009 were as follows (in thousands): December 31: 2011 2010 2009 Total $ 6,153 5,744 1,521 Fair Value Measurements Using Level 2 $ 3,360 1,249 Level 1 $287,078 87,078 Level 3 $ 2,793 4,495 1,521 The following table presents a summary of changes in the fair value of other real estate which is measured using Level 3 inputs: For the year ended December 31, Balance, beginning of year Loans transferred to ORE Sales and transfers to Level 2 Writedowns Balance, end of year 2011 $ 4,495 3,063 (4,129) (636) $ 2,793 $ 2010 1,521 4,466 (1,415) (77) $ 4,495 The carrying value and fair values of financial assets and financial liabilities at December 31, 2011, 2010 and 2009 are as follows (in thousands): Financial Assets: Cash and due from banks Available for sale securities Held to maturity securities Other Investments Federal Home Loan Bank Stock Loans, net Other real estate Cash surrender value of life insurance Financial Liabilities: Deposits: Non-interest bearing Interest bearing Total deposits Federal funds purchased and securities sold under agreements to repurchase Borrowings from Federal Home Loan Bank Carrying Amount $36,929 278,918 1,429 3,930 2,581 424,272 6,153 2011 2010 2009 Fair Value $36,929 278,918 1,492 3,930 2,581 427,881 6,153 Carrying Amount $24,147 287,078 1,915 3,926 2,281 403,248 5,744 Fair Value $24,147 287,078 2,010 3,926 2,281 407,363 5,744 Carrying Amount $29,155 311,434 3,202 4,036 5,016 457,148 1,521 Fair Value $29,155 311,434 3,341 4,036 5,016 460,588 1,521 16,196 16,196 15,951 15,951 15,329 15,329 97,581 370,858 468,439 157,601 53,324 97,581 372,019 469,600 157,601 55,014 108,278 375,862 484,140 140,102 42,957 31 108,278 376,715 484,993 140,102 43,990 96,541 374,160 470,701 174,431 104,270 96,541 375,052 471,593 174,431 105,815 P E O P L E S F I N A N C I A L C O R P O R A T I O N A N D S U B S I D I A R I E S R E P O R T O F I N D E P E N D E N T R E G I S T E R E D P U B L I C A C C O U N T I N G F I R M To the Board of Directors and Shareholders Peoples Financial Corporation Biloxi, Mississippi We have audited the accompanying consolidated statements of condition of Peoples Financial Corporation and subsidiaries (the “Company”) as of December 31, 2011, 2010 and 2009, and the related consolidated statements of income, changes in shareholders’ equity and comprehensive income, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consid- eration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion of the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opin- ion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the account- ing principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Peoples Financial Corporation and subsidiaries as of December 31, 2011, 2010 and 2009, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Atlanta, Georgia March 21, 2012 32 F I V E - Y E A R C O M P A R A T I V E S U M M A R Y O F S E L E C T E D F I N A N C I A L I N F O R M A T I O N ( I N T H O U S A N D S E X C E P T P E R S H A R E D A T A ) : Peoples Financial Corporation and Subsidiaries Balance Sheet Summary Total assets Available for sale securities Held to maturity securities Loans, net of unearned discount Deposits Borrowings from FHLB Shareholders' equity Summary of Operations Interest income Interest expense Net interest income Provision for loan losses Net interest income after provision for loan losses Non-interest income Non-interest expense Income (loss) before taxes Applicable income taxes Net income Per Share Data 2011 2010 2009 2008 2007 $ 804,152 $ 786,545 $ 869,007 $ 896,408 $ 927,357 278,918 1,428 432,407 468,439 53,324 109,452 287,078 1,915 409,899 484,140 42,957 101,357 311,434 3,202 464,976 470,701 104,270 103,588 340,642 3,394 467,377 510,476 36,938 107,000 386,029 4,630 450,992 569,130 7,100 106,542 $ 25,033 $ 29,675 $ 34,289 $ 43,573 $ 55,971 3,178 21,855 2,935 18,920 9,860 28,781 (1) (1,204) 4,601 25,074 6,845 18,229 10,114 27,581 762 (723) 7,401 26,888 5,225 21,663 10,147 27,636 4,174 954 14,963 28,610 2,347 26,263 7,268 26,520 7,011 1,977 25,452 30,519 (1,045) 31,564 9,767 ª25,263 16,068 5,042 $ 1,203 $ 1,485 $ 3,220 $ 5,034 $ 11,026 Basic and diluted earnings per share $ Dividends per share Book value .23 .19 21.31 $ .29 .20 19.68 $ .62 .50 20.11 $ .94 .56 20.27 $ 2.01 .52 19.56 Weighted average number of shares 5,136,918 5,151,661 5,170,430 5,342,470 5,489,861 Selected Ratios Return on average assets Return on average equity Primary capital to average assets Risk-based capital ratios: Tier 1 Total .15% 1.14% 14.65% 19.61% 20.86% .18% 1.45% 12.96% 21.01% 22.26% .36% 3.06% 12.49% 17.83% 19.08% .55% 4.73% 12.81% 18.03% 19.28% 1.15% 10.77% 12.13% 18.38% 19.63% 33 P E O P L E S F I N A N C I A L C O R P O R A T I O N A N D S U B S I D I A R I E S Summary of Quarterly Results of Operations (In Thousands Except per Share Data): Quarter Ended, 2011 Interest income Net interest income Provision for loan losses Income (loss) before income taxes Net income (loss) Basic and diluted earnings per share March 31 $ 6,787 5,862 641 288 438 .09 Quarter Ended, 2010 Interest income Net interest income Provision for loan losses Income (loss) before income taxes Net income (loss) Basic and diluted earnings per share Market Information March 31 $ 8,233 6,993 1,150 1,046 871 .17 June 30 $ 6,553 5,687 546 617 810 .16 June 30 $ 7,791 6,555 1,585 1,968 1,446 .28 September 30 $ 6,156 5,432 544 430 578 .11 September 30 $ 6,864 5,731 1,045 (33) 364 .07 $ December 31 5,537 4,873 1,204 (1,336) (622) (.13) December 31 6,787 $ 5,795 3,065 (2,219) (1,196) (.23) The Company's stock is traded under the symbol PFBX and is quoted in publications under "PplFnMS". The following table sets forth the high and low sale prices of the Company's common stock as reported on the NASDAQ Stock Market. Year 2011 Quarter 1st 2nd 3rd 4th 2010 1st 2nd 3rd 4th High $ 16.99 16.50 14.10 10.51 $ 23.12 16.47 14.83 15.62 $ $ Low 13.50 12.74 10.20 9.50 14.97 10.50 10.63 12.42 Dividend per share $ .09 .09 $ .10 .11 Performance Graph The graph below compares the Company’s annual percentage change in cumulative total shareholder return on common shares over the last five years with the cumulative total return of a broad equity market index of companies, the NASDAQ Market Index, and a peer group consisting of the Morningstar Industry Group, Regional - Southeast Banks (“Morningstar”). This presentation assumes $100 was invested in shares of the relevant issuers on January 1, 2007, and that dividends received were immediately invested in additional shares. The graph plots the value of the initial $100 investment at one year intervals. For purposes of constructing this data, the returns of each component issuer have been weighted according to that issuer’s market capitalization. 34 P E O P L E S F I N A N C I A L C O R P O R A T I O N A N D S U B S I D I A R I E S C O R P O R A T E I N F O R M A T I O N Corporate Office Mailing Address P. O. Box 529 Biloxi, MS 39533-0529 Physical Address 152 Lameuse Street Biloxi, MS 39530 (228) 435-8205 Website www.thepeoples.com Corporate Stock Shareholder Information For complete information concerning the common stock of Peoples Financial Corporation, including dividend reinvestment, or general information about the Company, direct inquiries to transfer agent/investor relations: Asset Management & Trust Services Department The Peoples Bank, Biloxi, Mississippi P. O. Box 1416, Biloxi, Mississippi 39533-1416 (228) 435-8208, e-mail: investorrelations@thepeoples.com Independent Registered Public Accounting Firm Porter Keadle Moore, LLC Atlanta, Georgia The common stock of Peoples Financial Corporation is traded on the NASDAQ Capital Market under the symbol: PFBX. S.E.C. Form 10-K Requests The current market makers are: A copy of the Annual Report on Form 10-K, as filed with the FIG Partners FTN Midwest Research Secs. Howe Barnes Hoefer & Arnett Knight Equity Markets, L.P. Morgan Keegan & Company, Inc. Sterne, Agee & Leach, Inc. Stifel Nicolaus & Co. Securities and Exchange Commission, may be obtained without charge by directing a written request to: Lauri A. Wood, Chief Financial Officer and Controller Peoples Financial Corporation P. O. Drawer 529, Biloxi, Mississippi 39533-0529 (228) 435-8412, e-mail: lwood@thepeoples.com 35 P E O P L E S F I N A N C I A L C O R P O R A T I O N A N D S U B S I D I A R I E S B R A N C H L O C A T I O N S The Peoples Bank, Biloxi, Mississippi BBiillooxxii BBrraanncchheess MMaaiinn OOffffiiccee 152 Lameuse Street, Biloxi, Mississippi 39530 (228) 435-5511 OOtthheerr BBrraanncchheess BBaayy SStt.. LLoouuiiss OOffffiiccee 408 Highway 90 East, Bay St. Louis, Mississippi 39520 (228) 897-8710 DDiiaammoonnddhheeaadd OOffffiiccee 5429 West Aloha Drive, Diamondhead, Mississippi 39525 AAsssseett MMaannaaggeemmeenntt aanndd TTrruusstt SSeerrvviicceess DDeeppaarrttmmeenntt (228) 897-8714 PPeerrssoonnaall aanndd CCoorrppoorraattee TTrruusstt SSeerrvviicceess 758 Vieux Marche, Biloxi, Mississippi 39530 DD’’IIbbeerrvviillllee--SStt.. MMaarrttiinn OOffffiiccee (228) 435-8208 CCeeddaarr LLaakkee OOffffiiccee 10491 Lemoyne Boulevard, D’Iberville, Mississippi 39532 (228) 435-8202 1740 Popps Ferry Road, Biloxi, Mississippi 39532 GGaauuttiieerr OOffffiiccee (228) 435-8688 WWeesstt BBiillooxxii OOffffiiccee 2609 Highway 90, Gautier, Mississippi 39553 (228) 497-1766 2560 Pass Road, Biloxi, Mississippi 39531 LLoonngg BBeeaacchh OOffffiiccee (228) 435-8203 298 Jeff Davis Avenue, Long Beach, Mississippi 39560 GGuullffppoorrtt BBrraanncchheess DDoowwnnttoowwnn GGuullffppoorrtt OOffffiiccee (228) 897-8712 OOcceeaann SSpprriinnggss OOffffiiccee 1105 30th Avenue, Gulfport, Mississippi 39501 2015 Bienville Boulevard, Ocean Springs, Mississippi 39564 (228) 897-8715 HHaannddssbboorroo OOffffiiccee (228) 435-8204 PPaassss CChhrriissttiiaann OOffffiiccee 0412 E. Pass Road, Gulfport, Mississippi 39507 301 East Second Street, Pass Christian, Mississippi 39571 (228) 897-8717 OOrraannggee GGrroovvee OOffffiiccee (228) 897-8719 SSaauucciieerr OOffffiiccee 12020 Highway 49 North, Gulfport, Mississippi 39503 17689 Second Street, Saucier, Mississippi 39574 (228) 897-8718 (228) 897-8716 WWaavveellaanndd OOffffiiccee 470 Highway 90, Waveland, Mississippi 39576 (228) 467-7257 WWiiggggiinnss OOffffiiccee 1312 S. Magnolia Drive, Wiggins, Mississippi 39577 (228) 897-8722 36 P E O P L E S F I N A N C I A L C O R P O R A T I O N A N D S U B S I D I A R I E S B O A R D O F D I R E C T O R S BB OO AA RR DD OO FF DD II RR EE CC TT OO RR SS PPeeoopplleess FFiinnaanncciiaall CCoorrppoorraattiioonn BB OO AA RR DD OO FF DD II RR EE CC TT OO RR SS TThhee PPeeoopplleess BBaannkk,, BBiillooxxii,, MMiissssiissssiippppii Chevis C. Swetman, Chairman of the Board Chevis C. Swetman, Chairman Dan Magruder, Vice Chairman; President, Rex Distributing Co., Inc. Tyrone J. Gollott, Vice-Chairman; President, G & W Enterprises, Inc. Drew Allen, President,Allen Beverages, Inc. Rex E. Kelly, Principal, Strategic Communications Jeffrey H. O’Keefe, President, Bradford-O’Keefe Funeral Homes, Inc. OO FF FF II CC EE RR SS PPeeoopplleess FFiinnaanncciiaall CCoorrppoorraattiioonn Chevis C. Swetman, President and CEO A. Wes Fulmer, Executive Vice-President Thomas J. Sliman, First Vice-President Jeannette E. Romero, Second Vice-President Robert M. Tucei, Vice-President Lauri A. Wood, Chief Financial Officer and Controller Ann F. Guice, Vice-President and Secretary J. Patrick Wild, Vice-President Evelyn R. Herrington, Vice-President A. Wynn Alexander, President, Desoto Land and Timber and Desoto Treated Materials, Inc. Drew Allen, President, Allen Beverages, Inc. A. Wes Fulmer, Executive Vice-President Liz Corso Joachim, President, Frank P. Corso, Inc. Rex E. Kelly, Principal, Strategic Communications Dan Magruder, President, Rex Distributing Co., Inc. Jeffrey H. O’Keefe, President, Bradford-O’Keefe Funeral Homes, Inc. SS EE NN II OO RR MM AA NN AA GG EE MM EE NN TT TThhee PPeeoopplleess BBaannkk,, BBiillooxxii,, MMiissssiissssiippppii Chevis C. Swetman, President and CEO A. Wes Fulmer, Executive Vice-President Jeannette E. Romero, Senior Vice-President Thomas J. Sliman, Senior Vice-President Robert M. Tucei, Senior Vice-President Lauri A. Wood, Senior Vice-President and Cashier Ann F. Guice, Senior Vice-President J. Patrick Wild, Senior Vice-President Evelyn R. Herrington, Senior Vice-President 

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